Good day, everyone, and welcome to the Moody's Corporation Second Quarter 2021 Earnings Conference Call. At this time, I would like to inform you that this conference is being recorded. [Operator Instructions]. I will now turn the call over to Shivani Kak, Head of Investor Relations. Please go ahead.

Thank you. Good morning, and thank you for joining us to discuss Moody's second quarter 2021 results and our revised outlook for full year 2021. I'm Shivani Kak, Head of Investor Relations. This morning, Moody's released its results for the second quarter of 2021 as well as our outlook for full year 2021. The earnings press release and a presentation to accompany this teleconference are both available on our website at ir.moodys.com. Rob Fauber, Moody's President and Chief Executive Officer, will lead this morning's conference call. Also making prepared remarks on the call this morning is Mark Kaye, Moody's Chief Financial Officer. During this call, we will also be presenting non-GAAP or adjusted figures. Please refer to the tables at the end of our earnings press release filed this morning for a reconciliation between all adjusted measures referenced during this call and GAAP. I call your attention to the safe harbor language, which can be found towards the end of our earnings release. Today's remarks may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. In accordance with the Act, I also direct your attention to the Management's Discussion and Analysis section and the risk factors discussed in our annual report on Form 10-K for the year ended December 31, 2020, and in other SEC filings made by the company, which are available on our website and on the SEC's website. These, together with the safe harbor statement, set forth important factors that could cause actual results to differ materially from those contained in any such forward-looking statements. I would also like to point out that members of the media may be on the call this morning in a listen-only mode. I will now turn the call over to Rob Fauber.

Thanks, Shivani, and good morning, and thanks to everyone for joining today's call. I'm going to begin by providing a general update on the business, including Moody's second quarter 2021 financial results. And following my commentary, Mark Kaye will provide further details on our second quarter 2021 performance as well as our revised 2021 outlook. And after our prepared remarks, as always, we'll be happy to take your questions. Moody's delivered strong financial results in the second quarter of 2021. Revenue growth of 8% and increase in adjusted diluted EPS of 15% highlighted the robust demand for our best-in-class integrated risk assessment offerings. Favorable market conditions and heightened M&A activity provided the backdrop for sustained leveraged finance issuance in the second quarter, and it supported growth in our ratings business. The ongoing expansion of our risk assessment solutions combined with strong retention rates drove MA's significant recurring revenue growth. Top line performance as well as expense discipline contributed to adjusted operating margin expansion, and our cost efficiency initiatives continue to fund key investments and product innovation that should support ongoing growth. As a result of our solid execution in the quarter, we've revised our full year 2021 guidance and now forecast Moody's revenue to grow in the low double-digit percent range. Additionally, we've raised our adjusted diluted EPS guidance to be in the range of $11.55 to $11.85. Now turning to second quarter results. MIS revenue grew 4%. That's despite the tough prior year comparable, while MA achieved its highest ever quarterly revenue, up 15% from last year. On an organic constant currency basis, MA revenue increased 8%. Moody's adjusted operating income rose 12% to $861 million, and the adjusted operating margin expanded 200 basis points to 55.4%. Adjusted diluted EPS was $3.22, up 15%. On the last earnings call,…

Thank you, Rob. In the second quarter, MIS revenue increased 4%, supported by a 3% rise in transaction revenue, while global MIS rated issuance declined 16%. As a result of favorable mix, corporate finance revenue declined 4% versus a 26% decrease in issuance. This was attributable to a surge in leveraged finance activity as U.S. and EMEA issuers opportunistically refinance existing debt and funded M&A transactions. Investment-grade supply contracted compared to the prior year period, which had seen significant liquidity-driven financing caused by uncertainty over the unfolding pandemic. Financial institutions revenue rose 6%, above the 1% increase in issuance. This is due to infrequent EMEA bank issuers who sought to take advantage of the ongoing attractive rate environment. Revenue from public, project and infrastructure finance declined 2% compared to a 45% decrease in issuance as increased non-U.S. project and infrastructure activity was offset by a reduction in U.S. infrastructure supply. Structured finance revenue increased 73%, supported by an over 200% growth in issuance. This is due to approximately 200 CLO deals this quarter, our highest on record, predominantly attributable to refinancing activity. In addition, CMBS formation further bolstered overall results. MIS' adjusted operating margin expanded 230 basis points to 66.3%. This was enabled by strong revenue growth, coupled with operating efficiency initiatives and lower legal accruals, partially offset by higher reserves for 2021 incentive compensation. Moving to MA. Second quarter revenue rose 15% or 13% on an organic basis. In RD&A, revenue increased 19% or 16% on an organic basis. This is due to robust demand for KYC and compliance solutions as well as strong customer retention rates and double-digit trailing 12-month sales growth in research and data feeds. For ERS, recurring revenue rose 16%, driving overall ERS growth of 5% or 3% organically. This reflected the demand for our…

Thanks, Mark. This concludes our prepared remarks. And Mark and I would be pleased to take your questions. Operator?

[Operator Instructions]. We'll go ahead and take our first question from Manav Patnaik with Barclays.

I guess I was just curious in terms of all the moving pieces around issuance, if you could help us with what the cadence looks like. I know you said second half will moderate, but are you assuming that 3Q continues kind of the run we've seen in 2Q and then 4Q is kind of a big, I guess we'll see what happens quarter. I was hoping any color there based on what you're seeing would be helpful.

Yes, Manav, good to have you on the call. We're now looking at low single-digit growth in global rated issuance. And obviously, that's an improvement from our outlook for low single-digit decline earlier this year. And that really is driven primarily by our improved outlook for leveraged finance and CLOs, and we have an expectation for those sectors to remain active in the second half. Year-to-date, global issuance has grown at something like 2% versus the prior year period. And while issuance conditions, we expect to remain favorable, our outlook for the second half of the year assumes moderating issuance in leveraged finance in the second half. And we just had a torrid pace of issuance in the first half. So we're looking for issuance to be roughly flattish to slightly down for the second half of the year versus up just modestly for the first half of the year.

And then we don't necessarily provide specific forecasts by quarter, but the general idea is really for MIS revenue to be slightly down in Q3 and slightly up in Q4. And that would be consistent with the historical issuance sawtooth pattern that we've seen.

That's very helpful, Mark. And maybe if I could just follow up, Mark. I think last quarter you gave us some numbers, but I don't recollect. But I was just hoping that, obviously, there's a lot of ESG activity going on. You guys have released a lot of new products and initiatives. Can you just talk, remind us of what the run rate of ESG revenues are and how we should think about what you're targeting there?

Absolutely. Second quarter ESG revenues were up just shy of 30% compared to the same period last year, and that reflects growth both on a stand-alone basis and also how we're integrating our ESG risk metrics and analytics into our MIS and MA products. And for the full year, we're looking for roughly $21 million on a stand-alone basis and then another $5 million to $10 million from integration into the 2 business segments. I also thought I'd just spend a minute on some of the commercial and product achievements this quarter on ESG because I think they're definitely worth highlighting. First on the commercial side, we saw very strong quarterly growth in climate, primarily bank stress testing and physical climate risk assessments for commercial real estate, corporate facility and infrastructure clients. We also saw very strong market demand for SPOs, and specifically for our SPO product, which has allowed us to drive success in that sustainable finance area. And then lastly, we've introduced on the commercial side a number of EU taxonomy offerings, which are going to really enable us to gain traction and have really supported some of the key wins we had in Q2. On the product side, a couple of really interesting new products to the market. The first is we launched the Regulatory Data Solutions, which has the SFDR principal adverse indicators. And that's really important because it's going to help investors with reporting obligations under the new EU Sustainable Finance Disclosure Regulation. We've also introduced the climate-adjusted EDF. And that allows us to integrate directly climate scenarios, which are based on the network for the greening of the financial system into our banking and other EDF models. And then third is really the one that Rob spoke about earlier on the SME Predictor Score. This is something we're particularly proud of. We think it's a tool that's a first of its kind. It gives us a competitive edge. And most importantly, it really allows customers to access more than 140 million ESG scores, which are then integrated into our existing Moody's products like Orbis, like compliance, Catylist.

Manav, so it's still relatively early days for us in ESG. But as you get a sense from Mark's comments, there's a lot of investment and a lot of product development going on.

We'll go ahead and take our next question from Kevin McVeigh with Credit Suisse.

Great. And let me add my congratulations as well. There's obviously a fair amount of cash that's been accumulating on the balance sheet. I know that's a high-class problem, but any thoughts, Mark or Rob, as to kind of capital allocation just given where the current cash balance sits?

Absolutely. So first and foremost, our priority when managing the balance sheet is really to ensure the business has the capital necessary to grow and the flexibility to operate effectively. Beyond that, we're going to seek to deploy the cash on our balance sheet, consistent with our long-held capital allocation policy, first, reinvesting in our business organically and then seeking appropriate M&A targets after that and then ultimately returning capital to shareholders by way of dividends and share repurchases. We do have a very strong corporate development team, and we look at a lot of M&A opportunities, though historically, we've executed very selectively, and we'll continue to do that, and that's demonstrated by our track record. That said, we do have some interesting larger bolt-on M&A opportunities, both in our addressable markets and consistent with our prior M&A approach. And they would fit well with our industrial logic and could meaningfully accelerate our integrated risk assessment strategy by bringing in new capabilities or by enhancing our current offerings and initiatives. Our outlook doesn't specifically include the impact of any future acquisitions. So to the extent we commit spending to and are actually able to act on an M&A deal, we would assess the need to update our plans for returning capital through share repurchases at that time.

Super helpful. And then just a quick follow-up. Given how much success you had on the ESG side and just the incremental market, are you investing enough, fast enough? Just any thoughts around that given the amount of kind of strategic initiatives that are out there today.

Yes, Kevin, this is Rob. I do think we're -- how are you doing, good to have you on the call. I do think we're investing enough and fast enough. As I said, Mark's comments about the new products that we've been rolling out give you a sense of the breadth of product development going on. And we've got integration going on across really every part of the business. So we're very focused on investing to meet the needs of our entire customer base around ESG and climate.

And I would simply add to that, we should expect to see an acceleration in expense incurrence really in the second half of the year. As we pick up the pace of organic strategic investment, you'll see a rather large increase in third quarter vis-a-vis fourth quarter related to expenses to support those activities.

We'll go ahead and take our next question from George Tong with Goldman Sachs.

You mentioned that you now expect low single-digit growth in global issuance versus your prior forecast of low single-digit decline this year. How is your outlook specifically for the second half that issuance changed over the past quarter? In other words, does the updated outlook reflect just flow-through of 2Q outperformance or has your outlook for the second half also improved?

I'll start, George, really just from an EPS perspective, and then certainly, we can go further into this in more detail. So really, the primary driver of our increase in full year 2021 adjusted EPS to sort of $11.70 at the midpoint of the latest guidance range is really the reflection of the actual and expected strong operating performance of MIS of 4% in the second quarter against what we thought is a very difficult prior year comparable. We have increased our EPS outlook versus the first quarter forecast by 4 to 5 percentage points really to reflect that. If I look specifically at the year to go 2021 adjusted EPS versus the prior year period, the guidance that we provided implies that, that will be down in the low single-digit percent range, and that's really due to 3 factors. Let's say, the approximately flat implied MIS revenue outlook for the second half of the year, and we can talk more about the comps and pull forward, if you would like. Secondly is the acceleration of the strategic investments that we have into the second half of the year. And then thirdly, just a small M&A hangover, maybe 1% or so there.

Yes. And the other thing I would add is just, given what we've seen with the leveraged finance markets in the first half of the year, I think that's where you've seen our outlook for the second half of the year as we've carried some of that strength through and see an improvement versus what we had projected earlier in the year.

Got it. That's super helpful color. And then just a quick follow-up, focusing maybe on MA, certainly strong performance there. Can you dive a little bit deeper into what's enabling success and growth there? And where you're investing and if you believe you're investing enough to sustain the growth that we've been seeing in MA?

Yes, sure. So MA has demonstrated a very strong track record for delivering kind of high single-digit organic revenue growth. And on these calls, we've been talking about some of the areas that are driving that, know your customer, obviously, one. The recurring revenue growth that we're seeing in our enterprise risk solutions, kind of risk as a service business, also in just our core MIS research and data feeds business as well as our private company data solutions. So just kind of touching on each of these a little bit to give you a sense of the nature of the demand and what's driving the growth, we talked about KYC and compliance. There's this demand for greater precision and automation of customer vetting. And we've got this emerging demand for understanding supply chain resiliency alongside that. So all of that is, we talked about in the webcast driving kind of mid-20s growth in that KYC space. Credit research and data feeds, we have some very high retention rates for that credit research, lots of demand for the data feeds. And I think that just reinforces the critical nature of that content when we're in times of market stress and uncertainty. The other thing I called out on my opening remarks, inside of ERS, you've got areas like insurance and asset management, and we thought it was worth calling out this quarter. Not only have we got ongoing demand for the IFRS 17 solutions, but increasing penetration of the buy side. This is defined benefit pension plans in the kind of risk technology and portfolio design space. And that was really enabled by our acquisition of RiskFirst. And all of this is kind of coming together and helping to drive some very good growth rates in that space. So we've got a very active product development pipeline across all of MA, and we expect we're going to continue to have opportunities to fill in product gaps and extend our capabilities to support ongoing growth.

We'll take our next question from Toni Kaplan with Morgan Stanley.

I wanted to ask about the ERS business. We've had about 3 straight quarters of low single-digit growth. And I know a lot of this is related to lower onetime sales. But I guess when does that fully get worked through? And like when you look at sort of next year and beyond, what's sort of a normal baseline growth rate for this business?

Toni, good to have you on the call. The key figure this quarter for ERS is recurring revenue growth, the recurring revenue growth rate. And that represented about 88% of total ERS revenue in the quarter. That's why we're so focused on that number. And recurring revenue in ERS was up 15% on an as reported basis and something like 9% on an organic constant dollar basis. And looking at the drivers of that recurring revenue growth, we had double-digit recurring revenue growth in both insurance and our risk and finance solutions. And I talked a bit just a minute ago about what's driving our growth in the insurance space. In risk and finance solutions, we've seen customers continuing to leverage a range of different offerings. We've got products, RiskCalc, RiskFrontier, all the support, credit loss reporting requirements and asset and liability and balance sheet management and our recent acquisition of ZM Financial enhanced that. Toni, you're right, so 15% recurring revenue, but overall revenue growth was 5% in the quarter. And that 15% recurring revenue growth was dampened by an almost 40% contraction in onetime business at ERS. And to the last part of your question, in regards to onetime revenue. I mean, we've got increasing customer preference for SaaS solutions. So that's naturally going to lead to a continued decline in our onetime revenue for the foreseeable future. That said, I would expect that the rate of decline for onetime revenue will decelerate in 2022 and eventually level off at some relatively de minimis level for our ERS business overall. We will still have some customers who want on-prem solutions, and we may decide to service that. But I think you're going to see that decline decelerate and then level off sometime next year.

And maybe, Toni, just to add a couple of numbers around that, think about onetime revenue at least for 2021 for both RD&A and the ERS lines of business as being around $20 million a quarter.

Very helpful. And then I wanted to turn to my favorite topic, MIS margins. Slide 22 was really helpful with the bridge for the overall versus the prior guide and from last year's expenses. But when I look at it, first half MIS adjusted operating margins were 67%. You're guiding to, I think, 61% for the year. So that implies like 53% margins in the back half. So this is obviously way below last year's margins, and last year included some nonrecurring items like severance and some extra incentive comp, and I know you're building in sort of more incentive comp in second half. But just how should we think about pacing of investment spend? How much of this is conservatism? Like just what are the pieces there?

Sure. Our updated guidance for the full year 2021 MIS adjusted operating margin, to your point, is approximately 61%. And that is 130 basis points higher than the actual 2020 adjusted operating margin of 59.7%. That is in addition to the MIS margin expanding by another 170 basis points in 2020. In the first quarter, we spoke about the primary drivers of our MIS margin. And what we're seeing in Q2, which we're partly flowing through to our full year outlook, is again an increase in operating leverage above a normalized run rate, and that's driven by better-than-expected issuance volumes and mix. It's underpinned by the expense discipline that you're observing. And it's important to keep in mind that we are planning to deploy part of that operating leverage really towards strategic investments in the second half to advance ESG capabilities, our technology stack, and it's really for the benefit of our customers to do that. We expect those actions really will bring down the third and fourth quarter MIS margin, to your point, below the 61% that we're guiding to for the full year. It's also worth just finally noting that MIS is carrying additional incentive compensation accruals associated with the better-than-expected issuance that will reset in 2022. So if we think about combining some of the onetime costs and incentive comp, the key point that I'm making here is that the go-forward expense run rate for 2022 is going to look a lot more like the first half of this year than necessarily what we might see in the second half of this year.

We'll take our next question from Alex Kramm with UBS.

Just coming back to the issuance, MIS outlook, I kind of want to ask a little bit more holistically. And I think if you put the last 12 months into context, I think everybody on this call, including you guys and myself, to be honest, of course, was obviously grossly wrong by a wide margin in terms of how the environment played out, right? So I think things have definitely been a lot better than everybody had thought. And so I'm just curious, from your perspective, as a manager, like how do you -- what would you isolate as like the biggest factors that have driven that upside? And when you think about the next 12, 24 months, how do you feel about that? Like how do you think that outlook has changed? Like do you feel much less confident now that some of these upside drivers that you've seen can continue to play out? And if so, which ones would they be?

Alex, it's Rob. Maybe let me talk a little bit about how we think about kind of the upside and downside to issuance. And you're right, it's been quite challenging to forecast for all of us. And then I might also touch on this question around pull forward because I think there's a bit of that at play and it gets into how we start to think about the outlook on a go-forward basis. But obviously, we've seen very strong activity in leveraged finance. And that's -- I think that's also part of the key in terms of how we're thinking about the second half of the year in terms of the issuance outlook. We've anticipated that there is some moderating of leveraged finance issuance in the second half of the year, as I said earlier, from the very, very strong levels we've seen in the first half. But if post-Labor Day, we see financing costs and market conditions where they are now and a continuation of the kind of issuance that we have seen for the last few months, particularly in leveraged loans, that could present some upside. Infrastructure, and I understand there may be some breaking news around potential agreement or bipartisan agreement around an infrastructure bill. I think it may have some impact in 2021, but more likely to have a positive impact to issuance in 2022. Then as I kind of think about the downside, and I was certainly hoping we were done with this topic, but any escalation of impact from another wave of infections or restrictions due to the Delta variant, I have to note we've got a potentially challenging comparable for the second half of the year. We had a very strong third quarter last year as spreads have tightened, and that even continued into the fourth quarter, and we had a pretty strong end to the year. Any increase in equity market volatility, that leveraged finance activity is often correlated to equity market conditions and equity market volatility. So that's something we're going to watch and of course, any market disruptions due to an unanticipated trajectory of inflation or interest rates.

Okay. Great. And then maybe just shifting gears here quickly. I'm curious about some of the proactive M&A commentary you've made in particular, the comment around larger bolt-ons. So I would love you to define some of that a little bit more. I mean, with BvD, I think you did the largest deal in history. But when you talk about larger bolt-ons, can you dimensionalize like how big something like this could be and what capacity you have? And then maybe related to that, it would be great if you can just remind us what you're looking for in terms of growth of some of these companies. You've done a great job doing some of these smaller deals and really accelerated them. But if you're talking about larger bolt-ons, I mean, is this something that also needs to accelerate the top line growth or is a lot of accretion, something that you care about? Like maybe just remind us, I mean, you have an M&A history yourself, right? Like what do you look for financially?

Yes. So Alex, maybe I'll first kind of clarify what I think of and I think what Mark means when we say larger bolt-on. I think of our acquisitions of RDC and Bureau van Dijk as a range of larger bolt-on deals. And I know we've provided -- we've got a number of questions about M&A over the last couple of quarters on these calls, and certainly, I refer everybody back to that. But I'm going to come back to, we're very focused on M&A opportunities in our addressable markets that are what I call on strategy and that are going to advance our risk assessment capabilities to better serve our customers' evolving needs. And you've seen us make acquisitions of high-value data and analytics that are critical to customer workflows and risk processes. That's why they end up having such high retention rates. We've been pretty clear about the areas where we're investing and building scale businesses, that is KYC and financial crime, where I think we've already made some very significant investments and as a result, have a very strong position in that market. Private company data, CRE data and analytics, commercial real estate is an area that we've talked about on and off over these calls. And we see a large end market and demand from our customers. And then, of course, ESG and climate. And climate in particular, climate is an area where there's a lot of near-term demand to understand the physical risk related to climate change from our customers. Within our ERS business, there are some further opportunities to continue to build out a more comprehensive offering for banks and expanding our offerings for insurance companies. You saw us do that with a very small acquisition of ZM Financial. We're doing that both organically and inorganically and building on both our existing customer base and growth in this space. So hopefully, that gives you some color.

And Alex, just to the second part of your question, from a capacity perspective, we are continuing to anchor our capital allocation and cash positioning policies really around that BBB+ rating. To give you a feel, our own Moody's calculation puts our net debt as of the end of the quarter at roughly $3.4 billion, $3.5 billion against a trailing 12-month adjusted operating income of around $3 billion. So we're looking at roughly 1.1x at this point.

And we'll take our next question from Owen Lau with Oppenheimer.

Could you please give us an update on the strategy and outlook of your business in China? So there are some news recently coming out from China. Could you please talk about if there is any like potential impact that could change Moody's view on China, if there's any?

Owen, it's Rob. Good to have you on the call. I think Mark and I will talk about a few of the developments that are going on in China. One of them, I think, you may be referring to is the data security law. And I guess, I would first say just as an integrated risk assessment business, policy developments, including those like on data security are very important factors that we consider for China and elsewhere for that matter and the impact both for Moody's and our customers. For just a little background for everybody on the call, China passed a new data security law in early June that's going to become effective, I believe, in September. And that law has some certain requirements around the localization of data and data transfer beyond China. And I don't think that it is going to impact our ratings business, but it has a broad scope, and the language of the law means it could impact other parts of our business as well as our customers and suppliers over time. But I guess I would say, Owen, that impact is going to depend on how we see these regulations being interpreted by the market and also how they're implemented by authorities. And that's going to take some time to play out. So we'll have to see. So as it relates to our long-term strategy in China, I don't think it changes it at this point. But Mark, anything to add to that?

Yes. Maybe very briefly, just to also note the regulators in both the exchange and the interbank markets did amend policies to remove the mandatory bond rating requirements on nonfinancial bonds over the last couple of months as well as the mandatory requirement for disclosure of credit rating reports for public issuance. Those regulatory changes may have a negative short-term impact on domestic CRA revenue. However, it's positive sort of from that medium to long-term perspective in transforming the current regulatory demand for ratings into a more sustainable market or investor-driven demand.

Okay. That's very helpful. I want to quickly go back to some of the reinvestments in MA in particular on KYC and CRE, Rob and Mark, you just mentioned. Do you expect these investments to drive top line growth maybe this year or next year? Or are those investments will increase the stickiness of your products? I'm trying to understand better how investors can think about the ROI of these expenses.

Yes. Look, both, I think, is the answer. We're certainly making enhancements to our existing products. But we're also rolling out -- we're also rolling out new products. And maybe since you mentioned it, let me just touch on commercial real estate, just to give you a sense, Owen, of what we're doing because it's a major asset class for our financial institution and investor customers. And that's why we really decided that we wanted to build out our capabilities here. And what we're hearing from customers is all about the integration of a range of data and insights and analytics to give them better insights and make better decisions, especially if that asset class is rapidly evolving. And the thing about commercial real estate, the investing and lending workflows have historically been pretty fragmented and manual. And that became particularly challenging amidst the COVID stress. So you know that a few years ago, we made an acquisition of a company to give us market and property data, but now we are making investments in lending and investing -- to help with lending and investing decision-making. And so there's a good bit of internal product build as well as we supplemented that. We made an acquisition earlier in the year to give us more listings data. So I think you are going to see an expansion of the product array in these areas as well as enhancements of existing products.

And we'll take our next question from Jeff Silber with BMO Capital Markets.

We hear and read a lot about the tight labor market in the United States. And I know in some other countries, you're seeing that as well. Is that impacting you at all, specifically maybe for some of the customer service reps or some of the lower-level positions? I'm just curious.

Yes. Like every company, we've seen a bit of an uptick in employee turnover as the pandemic drags on and job opportunities, I think, have increased. But to address that, we're doing a number of things, and that includes updating our market benchmarking to make sure that we're compensating our employees competitively and fairly. And it also very importantly includes giving our employees the flexibility they want and need in this environment. Our employees as well as prospective employees, so these are our recruits, have made it very clear to us that workplace flexibility is a very important part of their overall calculus when they are thinking about either staying at or joining a firm. So we see our flexible approach as a competitive advantage for talent relative to some financial institutions that have mandated 5 days a week back in the office. I would also say that our employees greatly value diversity, equity and inclusion, so that they can be their authentic selves and be at their best. And we have really prioritized initiatives to support DE&I. And I think the last thing is that employees also really want to work somewhere where they connect with the mission. And our employees come to work every day in support of our purpose as a company, and we talk about that being to provide clarity, knowledge and fairness to an interconnected world. And those aren't just words. They are at the heart of everything that we do. Our people are enormously committed to that purpose. And so that, I think, is also something that has a strong retentive effect for us.

Okay. That's really helpful. And then, Mark, one for you. You were very helpful providing quarterly guidance on the expense side. Can we get any color on the revenue side, what the cadence should be in 3Q and 4Q?

Yes, certainly, very happy to give you a general idea. I would look for really MIS revenue to be slightly down in the third quarter and then slightly up in the fourth quarter. And that's really driven by the historical issuance sawtooth pattern. You could think about similarity issuances being sort of down mid-single digits in Q3 based on our guidance and maybe up mid-single digits based on guidance in the fourth quarter. In terms of expenses, definitely, you'll see an acceleration in the third quarter relative to the prior year comparable and then expenses should be approximately flat in Q4. And that, of course, takes into account our accelerated strategic organic investments that we spoke about earlier.

We'll take our next question from Craig Huber with Huber Research Partners.

I, likewise, had a couple of questions on cost first, if I could. Mark, I think you said earlier on that we should expect costs next year to be more like your second half of '21 costs as opposed to lower first half of the year cost. Did I hear that right? And along the same lines I want to ask, incentive comp, I think that was $61 million in the first quarter. What was the second quarter? What's your outlook? And then I have a follow-up, if I could.

Sure. Just to clarify my earlier question on costs was specifically related to MIS. You should expect next year to look more like the first half of this year, just emphasizing that in the second half of 2021, we will be investing a lot in the business. In terms of incentive compensation, we accrued for the second quarter of 2021 approximately $81 million in incentive comp. And you should expect to see between $65 million and $70 million per quarter of accrual for Q3 and Q4 this year, purely driven by improved full year revenue and margin outlook. And just as a point of reference, that will be lower than the actual incentive comp accruals we took in the third and fourth quarter of 2020.

My other question I want to ask, what's your outlook for RMBS, CMBS and CLOs as you sort of think out here over the next year given the strength you've seen here and the added stock of bank loans output, please?

Yes, Craig. So maybe let me just start by talking about structured finance in the quarter and then give you some sense of what's contributing to our outlook. Our second quarter structured finance revenue in MIS was up almost 75%. And securitization activity kind of across the board was just very elevated, as Mark talked about earlier, a very active market in CLOs in part because you've got, obviously, an enormous amount of leveraged loan supply but also a lot of refinancing activity, and that's refinancing even of the 2000 vintage given the tightening of spreads in the CLO market, something like 70% of CLOs in this past quarter were refi. CMBS, which obviously kind of ground to a halt last year for a little while, we've also seen that rebound. That's primarily due to commercial real estate CLO transactions. And we saw spreads there continue to tighten and just the overall improvement in market conditions, and that brought back some -- a number of issuers who are on the sidelines. On U.S. and ABS -- sorry, U.S. ABS and RMBS activity, they're at probably the highest levels that we've seen in something like 8 quarters. And overall issuance in RMBS remains quite strong across the board. Spreads are still tight. There's been a little bit of widening recently due to all the supply, but nothing, I think, particularly immaterial. And in terms of talking to bankers in this space, Craig, we're hearing they don't see many signs of this softening or slowing down. Obviously, we're going to want to wait and see as we get through the kind of what will probably be a little bit slower August. But overall, ABS fundamentals are expected to continue to improve. We just got a lot of pent-up demand in that space and a general improvement in economic activity. And that the last thing I would say, Craig, that's contributing to our updated outlook on structured finance issuance for the year.

And we'll take our next question from Andrew Nicholas with William Blair.

Just wanted to ask a follow-up on one of your answers earlier in terms of the ESG product lineup. I know you rolled out Climate Solutions that suite in March and the ESG score predictor this quarter. I guess I'm hoping you'd spend some time talking about which client types are most interested in those products today. And then whether or not you have an opinion on how kind of the consumers of those products might evolve over time? And to the extent that, that would expand the addressable market for that business?

Sure. So maybe let me start with kind of where did this market start. And that -- as we think about the customer base, I think it really started with investors who are focused on socially responsible investing. And then that has obviously mainstreamed to equity and fixed income investors globally who wanted ESG content, right, for portfolio construction and portfolio monitoring. The customer base is now broadening out to essentially all of our customer types. So that includes not only investors but financial institutions, corporates and corporates that also includes issuers as well as governments. And I think the key theme here, Andrew, is that you're seeing the demand for integration of ESG. And considerations into a very wide range of customer processes. And -- like I said, that's everything from portfolio construction and monitoring, but you've got corporates who are engaged in sustainable finance and managing sustainable supply chains. You've got banks wanting to understand the ESG and climate risks of their borrowers and of the collateral that they are taking at securing their loans. You've got governments who are wanting to inform risk mitigation and investment around the physical risk related to climate change. And so that's why you hear us talking so much about integration across our entire product suite.

Perfect. That's really helpful. And then maybe somewhat relatedly for my follow-up. I was hoping you could give us an update on some of the Moody's specific kind of ESG initiatives underway and progress there is obviously an important topic for all investors, as you mentioned in the answer to the prior question.

Yes. As I think about Moody's specific ESG initiatives, we are very well positioned to help answer ESG-related questions for the business and to be able to bring transparency to the equity to fixed income and the sustainability markets more broadly. But let me touch on just a couple of areas that I think are of interest. The first is within our ESG research data and analytic products. One of our competitive differentiators is our focus on dual materiality versus just financial materiality. And that's because we've really built a combination of technology-enabled scoring and analytical overlays for the assessments that we're doing to be able to deliver really reliable, high-quality insights for our customers. The second area where we're very strong is on the physical risk assessment for climate, And that's both on the operational risk, whether it's looking at asset level data on exposure to flood, heat, stress, hurricanes, et cetera, as well as on the supply chain risk and sort of how that market risk capturing companies sort of resource use. The third 1 I mentioned is sustainable ratings, we are very strong, very active the first and second quarter for our insights on our product. And then finally, to the point that Rob made earlier, just integrating that into our MA product suite. It's certainly a differentiator for us. Now what we are hearing from clients directly and maybe to short that client quotes here, tailor-made solutions with access to ESG analytics and excellent subject matter experts.

We'll take our next question from Ashish Sabadra with RBC Capital Markets.

Congrats on solid results. I just wanted to focus on your private company data initiatives. Thanks for including the slide and the details on KYC and compliance, which obviously has been a strong area of growth. But I was just wondering if you can discuss the traction for other use cases for private company data and also talk about some of the organic and inorganic initiatives going forward to further expand your footprint in the private company data.

Good to have you on the call. You're right. I mean the kind of biggest and fastest-growing use case for a private company data is around know your customer. And as I mentioned earlier, we're starting to see emerging demand around addressing supply chain risks. So I might call that out. But our private company data fuels a whole range of both of use cases. And a few examples, tax and transfer pricing, trade credit, master data management, digital marketing, corporate development and the list goes on. And we're seeing some very good growth across the entire portfolio. The other thing I would say is we're integrating that data into a number of our different offerings. So for instance, you think about commercial real estate, when our customers are saying, "Hey, look, we want to have a more holistic understanding around the properties that we're either investing in or lending on -- as you can imagine, one of the key things to understand is the profile of the tenants in those buildings. So we're able to leverage that data. We're able now to have, with the ESG Predictor Score, give insights into the ESG profile of the tenants and of course, the credit profile of the tenants. We're also integrating that content into our ERS offerings. As you imagine, we've got our commercial banking customers who like the idea of being able to get that data into their origination platforms to enhance their own efficiency. So they're just -- there are a whole range of different ways that we are monetizing this data beyond KYC, and that's driving some very nice growth for us.

That's very helpful pillar. And just on a follow-up. I wanted to ask about your cross-sell opportunity, particularly on the insurance and asset management side? Again, thanks for including that slide and talking about the holistic offering there. But the question there was how well are you penetrated? How much more opportunity there is to upsell, cross-sell into your existing customer base?

Ashish, you're speaking specifically of insurance? Do I have that right?

Yes, insurance and asset management or if you want to talk in generality also like how well the offerings are penetrated and how much more room there is to just upsell cross-sell that necessarily going after new logos.

Yes. I guess maybe I'd start by just highlighting that our current insurance franchise is primarily focused on life insurance. And there are some. So as you can imagine, there's some reasonably good synergies between life insurance and asset management and kind of buy side. And so we've been able to expand our product offerings, first of all, by leveraging kind of those combined capabilities. And as we've seen insurance customers take one product, that gives us an opportunity then to cross-sell in multiple products. I talked about we started with regulatory compliance -- regulatory reporting, I think Solvency II, right, and then we evolved into actuarial modeling. And that's a very, very important function at life insurance companies. And then we developed these products around IFRS 17 and CECL. So what happens is kind of a land and expand strategy here, where we've got insurance companies who are taking one of these products and then increasingly taking multiple products.

We'll take our next question from Shlomo Rosenbaum with Stifel.

I want to circle back to some of the questions that were asked before, specifically Owen's question, just what's going on in China right now. I mean, in the media, it's reporting characterizing it as kind of a crackdown risk. It's more than just specific laws about some of the data privacy in terms of the regulatory environment becoming increasingly tight. I mean it's been commercial real estate finance, e-commerce, ride hailing, like education. Just how do you think about that in the context of your business both operationally in terms of operating in China and then also from a ratings perspective in terms of being able to rate the various businesses that are out there and what these changes in the regulatory environment might mean for your own recommendations.

Yes. Certainly, it's an evolving landscape. And we've all got to navigate these changes. We've done that, and we'll continue to do that in China. And I guess I would say that given the atmospherics also in U.S.-Sino relations, and I'm going to talk now about our approach to the domestic rating market because we get a lot of questions on these calls and other investor meetings. I continue to remain comfortable with our approach to the domestic ratings market, and that is to work through leading Chinese players because I think it is going to be challenging for wholly owned American companies to achieve leadership positions in nationally important industries in China over the medium and even long term. And certainly, what's going on today, I think, reinforces that view. In regards to the U.S. government's recent business advisory relating to U.S. companies operating in Hong Kong, obviously, Hong Kong is a very important business hub for us. As it relates to the substance of that advisory, I guess I would just say that we've got contingency plans in place for all sorts of potential business issues for our offices all over the world, and Hong Kong is no different.

Okay. And then just going back a little bit over here in terms of like -- I think Toni was asking about this on ERS. How much of ERS is still being impacted by the ability of your people to go over to clients and meet with in face of phase, get the implementations done. There definitely was kind of a lag in the business because of their ability to do that. I was wondering how much are you still being impacted by that? And are you seeing a change in momentum recently?

Yes. We talked about this when the pandemic unfolded in regards to kind of the big implementations, the on-prem, which as I talked about, is a much smaller part of our business now than it was. But that is the part that I think was more impacted by not being able to be on site. It's just the complexity of some of these on-prem solutions and installations, which I think challenged by being virtual. But I would say that we've done a great job of adapting to virtual engagement with our customers. And you see that from not only the recurring revenue growth, but our sales of the SaaS solutions in that business. So I think you're going to -- I think part of what is contributing to that, fairly significant decline in onetime is what you are touching on. But like I said, in terms of overall engagement with our customers, we've done a great job of adapting virtually.

Can I sneak in one more?

Please, Shlomo, go ahead.

It's just a real quick one. Just on Cortera, it looks like you've generated $3 million of revenue in the quarter. Is that a good run rate to assume for the whole year? Is that like a $12 million revenue business?

Absolutely. If I think about specifically Cortera and some of the other acquisitions that we've done, we feel pretty comfortable that the pace that we're executing at makes a lot of sense for our business and the direction in which we're going. And so I'd be comfortable again, same for you to assume sort of that level. If I just widen the aperture a little bit for the year, we're really looking for the 2021 M&A impact on our revenue number, inclusive of Cortera but not including RDC, to be around $44 million for the full year.

And I would also say that that's a very small bit of our overall data solutions business. And increasingly, what you're going to see is just that data they have is going to be integrated and into a variety of our different products. So we're not going to be particularly focused on the individual Cortera results, we're much more focused on what it's doing to support our broader data solutions business.

We'll take our next question from Patrick O'Shaughnessy with Raymond James.

I appreciate we've been going for a while, so I'll stay to one question. The Biden administration's nominee for Assistant Treasury Secretary for Financial Institutions, Graham Steel, has previously called for the SEC to enact structural reforms on your industry, credit rating agency industry, in particular. What's the current nature of your dialogue with the SEC and the Biden administration? And are you incrementally more concerned about potentially disruptive regulations?

Patrick, thanks for the question. And I guess I'd first say, as you expect, we have an active dialogue with our regulators and policymakers, both in the U.S. and around the world. And from time to time, our business model has been the subject of discussion by policymakers and it's been carefully studied in multiple jurisdictions. That goes back well over a decade. Most recently in 2020, there was an SEC advisory group that represented a broad cross-section of the market. And the conclusions have remained the same, which is allowing for a range of business models allows the market to function efficiently and effectively. And I would say that over the past decade, policymakers have substantially strengthened the regulatory framework around our industry. And we, as a company, and I believe, as an industry, have strengthened the processes and internal controls we have in place to manage conflicts of interest and provide the market with very high levels of confidence and transparency around our business. And we operate under a very robust regulatory oversight regime. We're going to continue to focus on maintaining policies and procedures that meet our regulatory requirements and provide the market with credit ratings that are independent and transparent and of the highest quality. And I guess I would conclude, Patrick, with saying over the last 18 months, as you'd imagine, I've met with a lot of issuers and investors and policymakers and regulators. And I think in general, the feedback is that we have done an excellent job at managing ratings throughout what I think I would characterize as kind of the ultimate stress test for credit ratings, which is the pandemic. And I believe that the market feels that it's been well served by the credit rating agency industry over the last decade.

We'll go ahead and take our next question from Judah Sokel with JPMorgan.

I appreciate you sneaking in here at the end. Earlier, you touched on MIS margins, particularly the delta between revenues being raised in the outlook, but not margins. I was wondering if you could talk about the MA margins where you kind of have the opposite dynamic, revenue guidance staying the same, but margin guidance was listed. So I was wondering what was happening over there, what you're seeing to change that outlook.

Maybe I'll start a little bit with some context here. So MA is focused on top line renewable growth through organic strategic investments, and that's really given the large opportunity set that we have in front of us, while concurrently looking to ensure margin expansion and profitability. And historically, we've done that, right? You've seen sort of that over -- or nearly 500 basis points of expansion since 2017. We have raised our MA fully allocated adjusted operating margin guidance to 30% to 31%, and that's 60 to 160 basis points higher than the 2020 actual number of 29.4%. If I think about the components of that, you see core margin expansion going up by approximately 230 basis points. And that's going to be offset by a combination of M&A that we've already done and organic investments that we've done and we plan to do of around 140 basis points that sort of gets us to that midpoint of 1 20. So we see a very strong leverage coming through in terms of the guide for the full year.

We'll take our next question again from Craig Huber with Huber Research Partners.

Mark, I wanted to go back to costs for a second here. once we hopefully get past this COVID-19 environment here, can you give us some help on how to think about your annualized costs that you think will come back in the system in terms of employees fully back in the office? Or how are we going to do that in terms of T&E expenses? So is it sort of like a $100 million rough number that will come back in the system once we get through this pandemic versus what we're tracking at right now?

So Craig, maybe a little bit of context and then I'll get to the specifics of your question. So most importantly, I think we as the management team are very pleased to highlight that disciplined expense management continues to create and maintain operating leverage and investment capacity for our business. If I think about just as an interesting comparison in answering your question, if I talk about sort of the first half of the year versus the second half of the year. So first half of the year, we saw operating expenses effectively up 5% year-over-year. And within that 5%, the underlying operating expenses, excluding M&A and FX, were effectively flat. And the reason for that was really because of some of the programs that we've implemented, which does include some T&E savings, but think about the 2020 real estate rationalization program, savings from the 2020 MA restructuring plan, which ended this quarter, the offshoring initiatives that we've engaged in really holding those operating expenses for the first half of the year effectively to 2-0 percent. M&A was about 3% and then FX was about 2%, and that's how you get to that 5% number for the first half of the year. Contrast that to the second half of the year, we are looking for operating expenses, excluding M&A and FX, to really try to -- to really accelerate -- and if we think about the mid-single-digit guide that we provided this morning, about half of that is really due to that underlying core operating expense growth. M&A is probably 2-ish percent of that and maybe FX maybe 1%. And so that gets us to really the expense ramp for the year. And we're looking at somewhere between $80 million to $90 million, and that would take into account all the additional incentive compensation accruals and any accelerated organic initiatives, investments in the second half.

And I'm sorry, but then once we look at the cost that right now, annualize, however you want to do it, versus when we get through this COVID-19 environment, how much extra cost of people come back when you have employees back in the office. You have T&E where you think is a reasonable level -- I'm assuming it's not going to get back 100% where it was pre-pandemic, but it's not going to be 0. If you add those two nuggets together, it's an extra roughly $100 million. How should we think about that in your mind or roughly 3% of cost?

So Craig, I appreciate the follow-up question. I was trying not to address that specifically given we're sort of in July, and we've got a little bit of time to go before the end of the year in which we provide our full year outlook for 2022. Just to give you a sense, the T&E this year is probably around 1/4 of what it would have been in 2019. So certainly, the run rate of T&E that we're expecting for the year is much lower. We do anticipate a portion of that coming back. But to Rob's comments earlier around the way that we think about workplace of the future and workplace flexibility, we have learned to operate in a more effective and efficient manner. We've also executed a number of procurement and other offshoring activities that have generated savings. And I realize the $100 million you're quoting is really based off of the $80 million to $100 million in cost efficiencies that we telegraphed previously. Some of those efficiencies will be redeployed back into investing in the business, and some will ultimately flow through to the bottom line, and we'll give a clearer update of that delineation when we do the outlook probably in February next year.

All right. It appears there are no further questions at this time. Mr. Fauber, I'd like to turn the conference back to you for any additional or closing remarks.

I just want to thank everybody for joining today's call and enjoy the rest of the summer. Be well and we look forward to speaking with you again in the fall.

This concludes Moody's Second Quarter 2021 Earnings Call. As a reminder, immediately following this call, the company will post the MIS revenue breakdown under the Investor Resources section of the Moody's IR home page. Additionally, a replay of this call will be available after 3:30 p.m. Eastern Time on Moody's IR website. Thank you very much.