Good day, everyone, and welcome to the Moody's Corporation Third 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 third 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 third 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 will be 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 U.S. 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, everybody, and thanks for joining today's call. I'm going to begin by providing a general update on the business, including Moody's third quarter 2021 financial results. And then following my commentary, Mark Kaye will provide further details on our third 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 robust financial results in the third quarter of 2021. Revenue of $1.5 billion grew 13% due to strong customer demand for our mission-critical products and insights. In both operating segments, revenue increased in the double-digit percent range. For MIS, attractive market conditions continue to drive opportunistic refinancing and M&A activity for leveraged loans and structured finance issuance. Meanwhile, MA experienced strong growth across our subscription-based products, which now comprise 93% of total MA revenue on a trailing 12-month basis. We remain focused on delivering our integrated risk assessment strategy through innovation and investment in high-growth markets, and I'll spotlight a few examples later in the call. As a result of our strong third quarter performance, we've revised our full year 2021 guidance and now forecast Moody's revenue to grow in the low teens percent range. Additionally, we've raised and narrowed our adjusted diluted EPS guidance to be in the range of $12.15 to $12.35, which, at the midpoint of $12.25, represents an approximate 21% annual growth rate. In the third quarter, MIS revenue was up 12% from the prior year and MA revenue was up 13%. Organic MA revenue increased 8%. Moody's adjusted operating income rose 2% to $737 million. During the third quarter, expense growth was higher than revenue as we invested significantly in our capabilities and product development in order to better serve a number of high-growth…

Thank you very much, Rob. In the third quarter, MIS revenue and rated issuance increased 12% and 11%, respectively, on elevated leveraged loan and CLO activity. Corporate finance revenue grew 6% compared to a 2% increase in issuance. Heightened demand continued for leveraged loans as issuers opportunistically refinanced debt and funded M&A transactions. Additionally, we observed lighter investment-grade activity compared to the record levels in the prior year period as well as a decline in high-yield bonds as investors pivoted to floating rate debt. Financial institutions revenue rose 14%, supported by 25% growth in issuance. Transaction revenue was up 24% as infrequent bank and insurance issuers took advantage of the attractive rate and spread environment. Revenue from public, project and infrastructure finance declined 2% compared to a 17% decrease in issuance as U.S. public finance issuers largely fulfilled their funding needs in prior periods. Structured finance revenue was up 63%, supported by strong recovery in issuance. While this was primarily attributable to CLO refinancing activity, the third quarter also had a high level of new deals driven by a surge in leveraged loan supply. In addition, CMBS and RMBS formation further bolstered overall results. MIS' adjusted operating margin benefited from approximately 190 basis points of underlying expansion, more than offset by the impact of higher incentive compensation associated with our improved full year outlook, a legal accrual adjustment in the prior year and a charitable contribution via The Moody's Foundation. Moving to MA. Third quarter revenue rose 13% or 8% on an organic basis. Ongoing demand for our KYC and compliance solutions as well as data feed drove a 15% increase in RD&A revenue or 12% organically. This was further supported by mid-90s percent retention rate and robust renewal yield for our credit research and data products. ERS revenue rose…

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

[Operator Instructions]. Our first question comes from Manav Patnaik with Barclays.

The first question is just on Moody's Analytics. I was hoping you could just help us with how much RMS specifically contributed in terms of revenue to the quarter and how we should model that out and the margin impact basically?

Good to have you on the call. I'm going to start kind of big picture with RMS because I think that will be useful to everybody on the call, and then we'll get Mark to drill down into some of the numbers. And I want to say that while we've owned RMS for less than 45 days, I think we're very excited about the prospects of what we can do together. And one thing that we found is that RMS, the combination of RMS and Moody's has made us a very important vendor to the largest insurance companies in the world. And that's leading to some really good dialogues and opening up some new opportunities for us. And we've got a plan to integrate RMS that's really focused around 4 key pillars. First is go-to-market strategies really in our insurance business, including cross-sell. Second is a road map for integrating RMS' capabilities across Moody's. And that very importantly includes climate as well as cyber and commercial real estate, to name a few. We've got some opportunities to sync and combine our tech stacks and road maps and then, of course, corporate integration. But to give you a sense of the cross-selling opportunity, in the core insurance space, less than 10% of our combined total insurance customers are currently served by both Moody's and RMS. So there's a lot we think we can do there. Let me give you a couple of examples, Manav, of where we see some relatively low-hanging fruit in terms of cross-selling and product integration in the insurance space. RMS has got something called LifeRisks and that focuses on a mortality and longevity solution. And we think we're going to be able to integrate that into our life insurance actuarial modeling platform and sell that to our…

Then Manav, as we think about the outlook, RMS' implicit impact to the full year 2021 adjusted margins and adjusted EPS was slightly larger than we previously forecast back in August, really due to 3 primary, I think about them as nonrecurring items. The first was increased transaction-related expenses of around $22 million. Second was a higher expected deferred revenue haircut in 2021 of $18 million. And then the third one would be the $13 million loss on the British pound purchase price hedge. If I take those three factors together with the underlying operating performance expected in 2021, we're looking at roughly a $0.29 dilutive impact to our full year EPS outlook. So if you put that in perspective, that will give you an idea of what needs to be adjusted out if you choose to from your models.

Okay. Got it. And then just from a margin standpoint, though, maybe on MIS. I think last quarter, you told us that the operating expense should be similar to the first half of this year. I just wanted an update if that's still the case or not.

Yes, Manav, maybe I'll spend just a couple of minutes to give a little bit more detail on the MIS margin. So we are guiding to a full year 2021 MIS adjusted operating margin outlook of approximately 62%. And that really means if you back into the fourth quarter of the year ago margin, we're looking at roughly 54.5%. And that would be up around a little bit over 600 basis points from the 2020 fourth quarter margin of that 48%. Of that approximately 600 basis points, you could think about almost 400 basis points is coming from underlying business performance. Think about ongoing favorable rate environment and need for continued M&A financing, et cetera, but also around, let's call it, 250 basis points from the nonrecurrence of some of those expenses that we saw in the fourth quarter last year, like severance. I also wanted to point out one item here that we are assuming historical fourth quarter issuance seasonality trends, which will imply a lower absolute fourth quarter MIS revenue result versus earlier quarters. So specifically in line with 2017 to 2020 quarterly seasonality, we're assuming 1/5 of 2021's full year MIS revenue in the last quarter of the year.

Our next question comes from Alex Kramm with UBS.

Was hoping that you could give us a little bit of an update or more detailed update than you already did on kind of like your expectations on the ratings and issuance side as we head into fiscal year '22. I understand given you haven't given us any sort of look yet, but it is November and clearly, everybody's kind of already moved on focusing on next year. And I think everybody can't ignore that the last couple of years have been really, really strong. So I appreciate your comments in terms of refi walls being a lot higher. And from a multiyear perspective, that looks really, really good. But when you think a little more near term in terms of fiscal year '22, what are the puts and takes that you are thinking about as you get into the budgeting process?

Alex, and I understand congratulations may be in order that you may have a new member of the family, so that's super. And we appreciate you still dialing into the call.

I appreciate this. Thank you very much.

I was actually looking back at the transcript from last year's third quarter call. I knew I was going to get this question. And I realize I'm probably going to sound a little bit like a broken record. So let me just give you some insight into how we're thinking about it. And you're right, Alex, we're not ready to give an official guide on our 2022 issuance outlook. We'll do that on the next call. But I think fundamentally, while the conditions are very, very conducive to issuance right now, and you noted it in your question, we have to take into account the very robust issuance environment we've had over the last, now, 2 years. And kind of like I said last year, from where we're sitting just right now, it feels like there are a little bit more headwinds than tailwinds going into 2022, and I'll give you a sense of both of those. So in terms of tailwinds, certainly, we've got a rebound in economic activity. We've always said that, that is good for our business. And assumption, our assumption is that inflation will, in fact, be transitory. And we've got a, we assume there's going to be a continuation of the very strong pace of M&A that's going on right now. And I think that's going to be particularly true in the case of sponsor-driven LBO activity. We've got private equity funds that just have huge amounts of money to deploy. We've got an assumption there's going to be a continued low rate and low default environment. And the low default environment is important because that's going to be supportive of tight spreads. So even as rates start to move up a little bit, we think that all-in financing rates will be historically attractive. And…

Excellent. Great color here. And a quick one just on the MA side. I know you talk about ESG and climate increasingly. I think still pretty early in terms of revenues. But in terms of where you're actually having success right now, can you actually give us a few examples where you're actually doing sales and like what kind of customers, what kind of products are resonating the most? And to what degree you're having competitive wins or what your win rate is because everybody is obviously trying to jump at this and grab as much as they can, but it's becoming a crowded field. So curious in terms of how you're doing relative to the competition, where you're winning the most.

Alex, thanks very much for the question here. Let me go ahead and maybe do a little bit of a holistic perspective, and I'll dive right in to specific areas that we're having success and sort of where our competitive advantage is here. Overall, the market itself is really coalescing around what we think of as 2 really important ESG themes. The first is really consistency, and that's really the need for more commonization and standardization. And the second is really around integration, right? The integration of ESG, climate and sustainability data, tools, analytics into our financial and risk workflows and products and services. And these two themes that could lead you to think about ESG as having a broader and deeper understanding of the important characteristics of who you're investing with or who you're lending to or who you're working with. And with that, let me highlight sort of those 3 customer examples to a part of your question. The first is in the CRE space where our customers want on-demand scoring capabilities to screen properties globally. And they want sustainability considerations to be integrated into that screening. And so we've developed a solution that provides those forward-looking risk assessments, property exposures to floods, hurricanes, wildfires and other climate hazards over time. And that's incredibly valuable and we're gaining significant traction there with our clients. A second example we can think about is banks and insurance companies. They're looking for climate data really to be integrated into economic scenario modeling and stress testing to really help them meet regulatory and other requirements. They also need it integrated into how they're assessing risk across their wholesale banking credit portfolios. And so we are doing that. We're helping to integrate those climate and ESG factors into our model. And that's, again, enhancing our competitive value proposition, including our lending software and other risk solutions that we provide to those financial institutions. And then maybe third, as a third example, customers ultimately want to integrate data sets. They really want to commingle their data with ours. And to enable that, we've made our data available on our new DataHub platform for customers to access our data alongside their own in-house data and then to work with that data using some of the advanced data science tools.

And Mark, let me just build on that too. Alex, you think about where do we think we have source of competitive advantage, you're right, it's a crowded field. I'll give you one example. We've developed what we call an ESG Score Predictor that's got scores on 140 million companies. Nobody else has that kind of coverage and we're leveraging that Orbis database that we have. We've got over 100 sales opportunity in the pipeline right now for organizations who want to be able to understand the ESG profile of tens of thousands of suppliers, for instance. So there's one example. Second, climate. With the addition of RMS, and we are just in the process of figuring out how we're really going to leverage that, we think we probably have some of the best climate modeling capabilities anywhere on the planet. And there's going to be a lot of demand for that. So in addition to kind of what we already had across the company and now layering in RMS and all of their capabilities, we think we're really going to be able to compete and win in the climate space.

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

I just wanted to focus on the KYC, and thanks for flagging the accelerated growth there. I was also wondering how is ESG driving increased demand for KYC. You've mentioned a couple of times about increased demand for third party, so any more incremental color there.

Yes. Great question, Ashish. So let me just start with KYC and financial crime compliance. As you can see, we're continuing to have very robust demand. We've got 26% constant dollar organic revenue growth in the third quarter. We feel very good about that. And we've got these foundational data assets with Orbis, 400 million companies, 1.5 billion total ownership links and then our GRID database with more than 14 million profiles. So that is a really comprehensive offering. And we've talked about the multiple use cases that are driving demand for all of this. And it goes back to what Mark just said. Organizations want to understand who they're doing business with, what are the risks of doing business with them and how can they make better and faster decisions to deliver immediate operational returns? And it's going beyond regulatory requirements and it's going beyond banks. And so to give you a sense of that, we're hearing from customers that they can do screens up to 5x faster with up to a 70% reduction in false positives using our tools. That's an anecdotal feedback we get from our customers. That's really important to them. And to give you a sense, Ashish, of the kind of scale of operations in our KYC business, we're now processing more than 700 million screens a day. So we're now building on this position. We've confirmed at least 10, what we call, innovation partners, which represent a range of well-known financial institutions, technology companies and corporates who we are now working with to co-create and shape industry-leading solutions. And those partners represent not only obviously attractive commercial opportunities but they give us really unique insights into industry trends and customer needs. And as part of all that, we're progressing on new product opportunities, things…

That's very helpful color. Maybe just my follow-up, I was wondering if you could provide any update on your China operations and any incremental color with what's happening there.

Sure. So I think everybody on the call knows, we're committed to our investment in CCXI. We have a 30% stake. It's the leading domestic rating agency. I know that the market has opened up to a number of financial services companies. But we'll see how successful those companies are relative to Chinese incumbents. What we do know is the Chinese want to attract more foreign investment into their domestic bond markets. And they need more transparency and more global comparability. That's what international investors want. So let me give you, Ashish, 2 ways that we are delivering what we think international investors want in order to facilitate investment into China's bond markets. The first is, we're about to launch something called China CreditView. We expect to launch it in November. And we think that's going to really address some critical needs across 4 areas. First of all, it's going to provide very wide coverage. So the platform is going to cover the top 1,000-plus Chinese corporates. And it will have global comparability. That's something else that's very important, standardized financials, credit metrics and model implied ratings on a global scale because that then allows for pure comparison globally, which is very important across both MIS-rated and kind of model-rated firms. It's going to provide transparency and some in-depth analysis with financial statement quality scores and interactive scorecards. So that's going to be very helpful to international investors. The second thing I would say is, given the credit stress and some of the regulatory actions across a range of Chinese sectors, I'd say that the demand for high-quality insights into China's credit market has probably never been higher. And to give you a sense, by year-end, our event activity covering Greater China will be up over 20% from last year. We'll have done 160 events. And we're increasingly really working under a One Moody's banner. A great example of that is our Moody's ESG China series. We're innovating in terms of our local delivery there. We're active on WeChat. We've got a special China channel. So a lot we're doing to drive engagement. We're even, I would kind of call it, bringing the world to China. We're including live Chinese translations into our global programs. And also to give you a sense of the activity levels, there's a lot of analytical and commercial engagements between our analysts and our commercial teams with issuers and prospective issuers, over 1,000 analytical meetings and thousands of commercial meetings. And then we've done a number of events with Chinese intermediates. So we feel like we've got some very good initiatives focused on the China market opportunity that are responsive to what the market wants and needs.

Our next question comes from Toni Kaplan with Morgan Stanley.

Actually, I just wanted to follow up on that last point you made, Rob. In the China CreditView, could you just confirm, it sounds like, is that more of an investor paid model that you're deploying within China or maybe I'm not understanding it correctly.

Yes. Toni, that's right. We have a flagship product called CreditView for fixed income investors. This is a, I would say, a special China-focused module of that with a broad coverage on Chinese corporates, as I just talked about. So yes, it would be a subscription-based model targeted primarily at our core international investor customer segment.

Perfect. Okay. Also, so you had some really, turning totally to a different topic. You've had some nice double-digit organic growth within RD&A for the past 5 quarters. A lot of moving pieces in there. You've got RDC, BvD, the legacy businesses. Slide 10 was really helpful for showing the drivers by theme. When you just think about the next 1 to 3 years, how would you rank order the areas of opportunity that you're most excited about within MA? And just on the sort of investment side, you have all these initiatives and innovation going on right now. I know it's really early, but should we think about the continued pace of investment similar next year to what you've done this year? Anything on sort of the opportunities and the investment would be great.

Yes. Toni, I'll start and then Mark is probably going to want to chime in as we think about investment. But let me start with RD&A because I think that's where your question started. Yes, we've got some very strong organic growth coming out of that. You're right. There's a number of things that are included in that segment. The KYC, obviously, I talked about that at some length. But let me also talk about what else is driving growth there, and that's our research and data feeds. We've got very strong retention, something like 96% in the third quarter of '21. And that growth is supported by deepening our penetration at existing customers and adding new logos. And we're making, and I was talking, Toni, about our flagship CreditView research platform. We're making some significant investments and enhancements to be able to support our value proposition and obviously our pricing opportunity over the coming years. So to give you a little bit of a flavor for that, we're now going to be aggregating insights and analytics that we've developed across all of Moody's so that our customers can access, you hear this term, integrated risk capabilities in one place. We're going to be upgrading and delivering more of a true digital experience that is going to enable our RD&A users to consume, really CreditView users, to consume content where, when and how they want it. And I think very importantly, we're going to be servicing the entire breadth of the ESG and climate content across Moody's to be able to integrate, enable integrated risk assessment on credit risk and dual materiality. So there's some very good investments there. Then maybe the last thing, I'll hand it to Mark is, and you're right, there are a number of great places for us to be investing across MA. We've got the bubble chart that shows you. You've got a number of businesses doing more than $100 million in revenue. So I would go back to, KYC is a very attractive place for us to invest given the growth characteristics and our position and then things like banking and insurance within ERS, CRE and then climate and ESG.

Toni, if I were to just add a couple of numbers around that. For the full year 2021, we're looking to invest approximately $110 million. And just to give you a feel because this obviously ties back with the expense calendarization by quarter, we spent approximately $30 million in the third quarter and we're looking at somewhere between $45 million and $50 million in the fourth quarter. And a significant portion of those strategic investments, as Rob said, would be allocated to our KYC, CRE, ESG and climate. Maybe just a quick flyby on KYC. Obviously, that's the integration of the acquisitions from RDC, Cortera and Acquire Media. And that's all about best-in-class KYC and financial crime prevention. I just wanted to make a note here. We have a really great customer feedback on our new insights around human trafficking alerts and some of the identity verification. On CRE briefly, it's around streamlining our customers' workflow for lending, investment and monitoring. ESG, I think we've sufficiently spoken about. And then lastly, in the domestic China and Latin American markets, we are investing in some of the local talent, region-specific methodologies and more of a holistic suite of products that meet the specific market needs.

Our next question comes from Kevin McVeigh with Credit Suisse.

Mark or Rob, I wanted to ask the kind of rate question a different way. I mean, obviously, there's been a nice uptick in structured finance to offset some of the corporate finance weakness. But if I go back, you're still kind of 40% below the '07, '08 peak in structured finance, right, if you look at your revenue, yet kind of corporate finance is 5x what it was. Do you have any thoughts as to structured finance revisit that prior peak? I know the dynamics are a little bit different, but any thoughts as to does that continue to offset maybe some of the uptick in rates? Or just I'm asking that more within the context of the rating stack relative to how we're thinking about rates a little bit longer term, I guess, '21 to '22.

Kevin, it's Rob. Let me take a crack at this. I guess the first thing that comes to mind here is just, when we're talking about 2007, if we went back and looked at the size of the RMBS market, that's going to be a very big piece of that, that just has not come back to anything like what it looked like pre-global financial crisis. And we get asked from time to time, do we think it will and there have been some proposals around the GSEs and other things. But the reality is, it just doesn't seem like something that's probably in the near to medium term. So it's hard to replace that amount of issuance in the overall structured market. That said, if we kind of just look out right now today, we see, especially in the U.S., pretty vibrant markets for structured finance across all asset classes. Obviously, CLOs is, you saw our guidance, up 100%. But ABS, very tight spreads in that market, improving consumer confidence. You've got CMBS, which has been surprisingly resilient coming out of the pandemic and of course, CLOs. So I think we're going to see good growth in structured finance, but I don't think it's going to resume the same kind of absolute size that we had pre-financial crisis anytime soon.

That makes a lot of sense. And then just real quick, given all the incremental commentary from RMS in terms of how it's syncing with climate, are you still comfortable with that $150 million of incremental revenue by 2025 or are you seeing anything as to the pacing of that? It sounds like maybe that proves conservative as you're kind of working your way through the client base.

We are very comfortable to continue guiding towards the incremental RMS-related run rate revenue of $150 million by 2025. I'd also just note that connected to that is the guidance that we are reaffirming around our medium-term MA adjusted operating margin of mid-30s. So certainly, we feel very comfortable sort of reaffirming those outlooks.

And Kevin, I don't want to get ahead of ourselves, but we're going to be thinking hard about how Moody's and RMS together can play an important role in addressing climate resilience, obviously, enormous investments being made. The Biden plan, I think we've got more visibility on that today. So that will be something we'll be very focused on.

It seems like it's a real future opportunity for you, for sure.

Our next question comes from George Tong with Goldman Sachs.

I wanted to drill into margins a bit. As you think about the attribution of margin performance, how do you expect MIS and MA margins to perform in the fourth quarter?

George, maybe let me start more holistically at the MCO level. I provided a little bit of color a minute ago on MIS, but let me talk about MCO and then I'll talk a little bit about MA after that. Our updated guidance for full year 2021 MCO adjusted operating margin is approximately 51%, and that is 130 basis points higher than the actual 2020 adjusted operating margin result of 49.7%. For context, this is in addition to the MCO margin expanding by 240 basis points in 2020, so a significant expansion. If we were to break the MCO margin expansion down into its component pieces, that would translate into an increase in operating leverage by around 300 to 350 basis points. And that's versus the 150 to 250 basis points that we guided to previously. And this is driven really by better-than-expected scalable revenue growth underpinned by expense discipline. We are also able to realize savings and efficiencies of between 160 and 200 basis points of MCO margin from activities like the restructuring programs that we implemented last year, increasing automation, utilization of lower-cost locations, procurement efficiencies, real estate optimization, et cetera. And the idea that we've spoken about is then sort of fully deploying those savings and efficiencies against increasing our organic strategic investments in 2021 and especially in the third and fourth quarter of this year. And if I just were to round out sort of that attribution, we're really looking at 150 to 190 basis points of headwind from the recent acquisitions, including those RMS transaction-related costs, and around 25 basis points of mix between the MA and the MIS business growth. On MA specifically, we are guiding to approximately 29% for the full year. And that means the implied fourth quarter MA margin is approximately 24%. And that is down from last year's result of 28.4%. That's driven almost solely by more than 400 basis points of margin compression resulting from the M&A activity and transaction-related costs. The underlying fourth quarter margin is really expected to be approximately flat year-over-year. And that's primarily because we're accelerating our organic investments really, again, in the third and fourth quarter this year. And just to remind, and I know I mentioned this a minute ago but I want to reiterate, the medium-term MA adjusted operating margin guidance remains in that mid-30s percent.

Got it. That's helpful. On the topic of reinvestments, you're making reinvestments of about $80 million to $100 million from the cost savings that you're realizing. Can you talk about which parts of the business those reinvestments are going into and what's been done year-to-date?

Absolutely. So to be precise, we're looking to reinvest approximately $110 million back into the business this year. And that really is through those cost efficiencies that we've been able to generate, primarily in the areas of KYC, CRE, ESG and climate. And I know we've spoken about those before. I also wanted to add, it also relates to modernizing some of our internal data and technology infrastructure, and that's about enhancing our products and expanding our presence in the emerging markets. And then, of course, we cited a couple of examples earlier on the call around the DataHub, the cloud-based analytical platform. So there are several areas that we're using to enhance organic investments.

Yes. Let me give you an example. So for instance, in commercial real estate, obviously, we made an acquisition at the beginning of the year, Catylist, to build out our coverage. We also have been investing organically and that's coming out of that investment fund. And really, there's 2 products in particular. At the end of the third quarter, we launched our CreditLens for commercial real estate product. That's targeted at CRE lenders. Those are our core customers. And that product delivers a more digitized and automated and connected approach that's going to reduce underwriting time for our customers. And we're building out a sales pipeline and we're excited about that. We're also scheduled to launch our portfolio construction and monitoring product for CRE investors this coming month. And similarly, we're out speaking with prospective customers there. That gives you an example of the kind of thing that we're doing out of that investment fund.

Our next question comes from Andrew Nicholas with William Blair.

This is actually Trevor Romeo on for Andrew. First, just you touched on this a bit in the prepared remarks, but I was just wondering if you could maybe talk a bit more about your investment in BitSight, your thoughts on kind of the market for cybersecurity ratings and analytics and how that investment enables you to take advantage of that opportunity.

Trevor, welcome to the call. So I probably don't need to say that cyberattacks are growing in frequency and severity. They're affecting a much broader range of industries. And as I think we all understand, it's not just data breaches anymore. This is about, also about the physical security of infrastructure. And we had done some interesting work in RMS. We had looked at the sectors that we consider to be medium high or high cyber risk. 13 sectors, total rated debt of more than $20 trillion. So the numbers here are big. And I guess what I'd say is, it's a growing problem, material implications, but the real issue is it's very opaque. There is little ability of financial markets to be able to quantify cyber risk. And this is a critical area of concern with virtually every customer that I meet with. It's probably not surprising. So we think that our investment in BitSight has established the standard at scale in cybersecurity ratings and risk assessment in a way that's, frankly, seriously needed and hasn't been done before. So think of this as they've got an outside-in approach. That's essentially what a company looks like to the Internet and then they translate that to something that looks kind of like a FICO score. And then in the transaction, we combined our joint venture that had our inside-out approach. And that's working with management and doing a more in-depth analysis, similar to what you might think of with a credit rating. So together, BitSight's got the most comprehensive cyber risk assessment capability in the market, and we think it's going to be uniquely well positioned to help quantify the financial exposure to cyber risk. And there are a few things that really attracted us to BitSight. They've got first-mover…

Okay. Great. That was super helpful. And maybe just a quick follow-up for Mark. Apologize if I missed this, but what was the incentive comp number in the third quarter and your expectation for Q4?

The incentive compensation result for the third quarter was approximately $107 million. And we're now expecting incentive compensation to be between $325 million and $330 million for the full year. And that's an increase of around $60 million from our second quarter forecast really due to the improved full year revenue and margin outlook of low teens percentage growth and approximately 51% adjusted operating margin, respectively.

Our next question comes from Craig Huber with Huber Research Partners.

My first question, Rob, if you just, back on the RMS acquisition, you talked an awful lot about your climate risk models here, the data there, how it's applicable to the insurance industry. But can you touch on the other industries out there? This seems like a huge opportunity long term to sell those capabilities into other areas outside of insurance. That's my first one.

Yes. That's exactly right, Craig. So you think about RMS for 30 years has been supporting the insurance industry in underwriting weather risk, call it climate risk, weather risk, right, among other kinds of risk as well. They've obviously developed models beyond extreme weather events. But I think what we're all realizing is that weather risk and the physical risks related to climate change are no longer just the insurance industry's problem. In fact, the insurance industry is going to be very thoughtful about what they insure on an ongoing basis, right? So you can imagine you're a bank, you've underwritten a 10-year loan and during the life of that loan, an insurance company decides they're no longer going to insure the collateral because they're concerned about the climate risk. And all of a sudden, the bank then inherits the climate risk. You've got, I think, a broad understanding now of the impact of weather. There's a whole range of knock-on impacts. I'll give you an interesting data point, Craig. Over the last 30 years, there have been something like $400 billion of insured losses related to weather events, but there have been something like $1.3 trillion of uninsured, right? So this is flowing through organizations' P&Ls, business interruptions, supply chain disruptions, changes to consumer, all those kinds of things that companies have been effectively retaining that risk. And I think organizations around the world are waking up to realize they want to get much smarter about that risk, especially given concerns about climate change. The other thing I would say, Craig, is and we can touch on what's going on with the infrastructure and Build Back Better bills, there is going to be a lot of investment in climate resilience, right? So this is trying to understand, let's say, you're a municipality. You want to understand what is the impact of climate change on your municipality? And what kind of investments should you be making in risk mitigation, adaptation and building climate resilience? And there are going to be trillions of dollars over the next several decades going into thinking about not just carbon transition but also address building climate resilience. And that is where we think the RMS models, combined with our expertise from Four Twenty Seven and other things, we think they are going to be very relevant in helping governments, corporations, financial institutions be able to start to much better zero in on those kinds of risks and think about how it will inform investments.

That's great. My other follow-up, Rob, bank loan issuance, the outlook there. I mean, these private equity firms out there, as you alluded to earlier, are very flush with capital, cash on the balance sheets and stuff. And it looks to us like 50% to 60% in recent years of bank loan issuance is sponsored related to this stuff. I mean, can you just talk a little bit further about the outlook here, particularly given how low credit spreads are and absolute rates as well, just the bank loan outlook.

Yes. I'd say, Craig, near term, the bank loan outlook looks good for the reasons that you cite. You've got lots of dry powder from the sponsors. You've got low default rates and low forecasted default rates and very tight spreads, low benchmark rates, lots of M&A activity going on, so the outlook for leveraged loans looks good. I think the only question on our mind is really when the dust settles on the year, like we said, volumes are going to be up something like 100%. And the question is, will there be a period of digestion like we saw with investment-grade this past year? Or are we going to see some of these underlying drivers continue to allow the loan market to grow off of these record levels? I don't have an answer for that yet, but we will give you a view on the next call.

Our next question comes from Jeff Silber with BMO Capital Markets.

We've been hearing a lot these days about the labor shortage and wage inflation. I just was wondering if you could talk a little bit about your own labor pool, what you're seeing. Is it any different than it has been over the past few months?

Yes. I'd say a few things. Like probably almost every company in the United States, we're seeing the same pressures that's led to a little bit of an uptick in our turnover on a historical basis, but we've also picked up our pace of hiring. So I guess what I would say is that, yes, we all hear about some of the compensation issues, but we're also really trying to focus in on the other things that really attract and retain people at a company. And I think that has really evolved over the last, even just since the pandemic. I mean, we see young people but I think all of our people, they want to work at a company that has a purpose and where they feel connected to the mission. And I can assure you that our people are very purpose and mission-driven at Moody's. We're doing some exciting things around combating financial crime and addressing and helping the world address climate change and all the things that we're doing, and the rating agency that plays such an important role. But then you've also got workplace flexibility. And that is going to be a very important factor in terms of retaining talent, not just about what am I getting paid but where am I going to work? And I can say that we've adopted a pretty flexible approach. I think most of our employees will be in a hybrid mode. We've given lots of flexibility. And frankly, our employees have earned it. They've done a super job over the last 2 years of working remotely. And I think we're really excited to empower our employees to take advantage of that kind of flexibility. And we see that as an opportunity to really, a possible competitive advantage in terms of attracting talent going forward.

All right. That's great. And just the second, a quick numbers question to Mark. Mark, can you just let us know what the annualized intangible asset amortization is now that you completed the RMS deal?

Specifically, let me start with RMS and then I'll move on to the broader. So we are still reviewing the intangible asset valuation for RMS. We do expect the allocation of the purchase price to be very much in line with historical norms. That's going to be around 40% of those amortizable intangible assets. What that translates to is around $17 million really for 2021 pretax and around $59 million pretax really looking forward from 2022. If I combine that holistically across the portfolio for the full year 2021, we're looking at combined depreciation and amortization of around $260-ish million, of which I would say around $158 million, maybe $160 million is really purchase price amortization for this year, and the remainder would be other regular depreciation and amortization.

Our next question comes from Andrew Steinerman with JPMorgan.

Mark, it's Andrew. I want to look back to Slide #19. And could you just tell us what the fourth quarter issuance year-over-year is implied when you state high single-digit growth for the full year '21? And then I want you to compare that, on the same slide, to the MIS revenues. When you say low teens revenue growth for MIS revenues for the full year, I think that implies 8% or about 8% MIS revenue growth for the fourth quarter. Could you just confirm that? And then share with us the drivers between issuance change year-over-year and MIS revenue growth for the fourth quarter.

Andrew, thank you for your question. So we are guiding to an MIS revenue outlook of sort of low teens growth for the full year. I'd argue maybe that's towards the higher end of low teens. And that does imply, to your point, year to go MIS revenue in probably the high single digits and maybe I'll add a higher end of high single digit for MIS. On the issuance side, we are guiding towards high single digits for the year, and that would imply really mid-teens issuance growth in the fourth quarter. And you are seeing a little bit of negative mix in the fourth quarter as a result of that guidance. And that's primarily driven by the structured finance or specifically, the CLO asset class within structured finance, where you see greater than sort of 100% year-over-year guidance. The issuance itself doesn't necessarily translate as well vis-a-vis some of the other asset classes into per dollar revenue. So that should explain sort of those impacts to you.

And our next question comes from Owen Lau with Oppenheimer.

I have two quick questions. First one is, Mark, could you please give us an update on the ESG revenue this quarter? And then have you changed any expectation of those ESG revenue contribution going forward?

Owen, we are still continuing to guide to a full year ESG revenue of approximately $21 million on a stand-alone basis and then an additional $5 million to $10 million of ESG revenue through integration of our ESG analytics into the MIS and MA products and solutions. For the third quarter itself, year-to-date, ESG revenue is very much in line with expectations, growing well over 20%. So we feel comfortable about meeting the targets for this year.

Got it. That's very helpful. And then another one about the tax rate. I think there are lots of noise and conversation about the corporate tax rate next year. How does Moody's think about the tax rate going forward? And if any, would you make incremental cash tax payment, something like that?

Owen, thanks for the question here. So let me step back just for a minute and address your question holistically given tax is a very fluid area at the moment. And so it may be somewhat premature to speculate about potential impacts. So with that said, there are really 3 primary areas on our tax watch list that we are actively monitoring. First, and this one is probably a little bit obvious, is the Biden administration's tax proposal and the implied impact to Moody's go-forward effective tax rates from potential revisions to the corporate, the GILTI or the FDII rates. However, based on the releases that we've seen this morning of the Build Back Better legislative framework, those items are maybe looking less likely. And instead, we're more likely to see potentially a 15% minimum corporate tax on large corporations as well as possibly a 1% surcharge on corporate stock buybacks. So things are evolving quite quickly here. It's a rough order of magnitude depending on where we actually end up. A 1% change in the effective tax rate would correspond to around a $0.14 impact to the 2021 adjusted EPS. The second one that we're looking at is clearly the OECD, the pillars #1 and 2 around a global minimum and a digital services tax and then obviously that impacts on transfer pricing. And then third and finally relates to changes to tax transparency and tax governance, and that's really part of the integral element of corporate ESG. For example, the recently issued standards on this by the Global Reporting Institute. We are guiding to a full year effective tax rate between 19.5% and 20.5% for full year 2021. And so that is just north or well north of the 15% proposed minimum corporate tax. And so we feel comfortable with where we are.

And we have no further questions at this time. I'd like to turn the conference back to Rob Fauber for any additional or closing remarks.

Okay. So before we wrap it up, just an advertisement that Moody's will be hosting our next Investor Day on March 10, 2022 in New York City. It's going to be a great opportunity to learn more about our business, and we hope to have many of you attend that in one way or another. So with that, thank you for joining today's call. We look forward to speaking with you again in the new year. Take care.

This concludes Moody's Third 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 homepage. Additionally, a replay of this call will be available after 4 p.m. Eastern Time on Moody's IR website. Thank you.