Moody`s Corp (MCO) — Q2 2021 Earnings Call Transcript

Thank you. Good morning, and thank you for joining us to discuss Moody's second quarter 2021 results and our revised outlook for the 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 the 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. Following my commentary, Mark Kaye will provide further details on our second quarter 2021 performance as well as our revised 2021 outlook. 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 an 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 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, I highlighted that issuance volumes reached their highest level in over a decade. This quarter, as anticipated, investment-grade activity declined as many issuers had already substantially fulfilled their funding needs in recent quarters. Although overall issuance declined by 16%, as you can see on the chart, second quarter issuance was still well above the historical 10-year average. While the growth in leveraged loans outpaced high-yield bonds, the demand that we saw earlier this year from both asset classes persisted, albeit a bit slower sequentially. We also saw increased momentum in the CLO market, driven by opportunistic refinancing as spreads remain tight. We frequently comment on our revenue relative to issuance levels, which relates to issuance mix. In the second quarter, transactional MIS revenue grew 3%, while MIS rated issuance declined 16%. This chart provides an illustration of our second quarter issuance and revenue mix by asset class. For example, the dark green bubble on the bottom left corner represents investment-grade issuance. And you can see that issuance was down 68% in the second quarter versus the prior year. However, leveraged loans, which has a greater proportion of issuers on per issuance or pay-as-you-go commercial programs, represented by the dark blue bubble on the far right, saw issuance up over 200%. That significantly contributed to this quarter's favorable issuance mix. Similar to last quarter, favorable market conditions led issuers to access the debt markets for a variety of reasons. Credit spreads tightened as default rates trended lower, keeping the overall cost of debt low and allowing issuers to opportunistically refinance existing debt. As the economy started to recover and equity markets continued their strong run, we saw an acceleration of M&A as companies use the combination of cash balances and debt financing to acquire growth and position businesses for the post-pandemic economy. We expect this constructive environment to persist, providing issuers further opportunities to tap the markets. That said, we forecast activity for the remainder of 2021 to moderate from the historical highs that we saw in the first half of this year. And Mark is going to go into further detail on our issuance guidance by asset class later in the call. Now let's turn to MA. MA's growing recurring revenue base and strong retention rates demonstrate the market demand for our products. Our emphasis on renewable sales has increased the proportion of recurring revenue by 4 percentage points in the trailing 12-month period to 92%. We continue to see significant opportunities in know your customer and financial crime compliance solutions as well as areas like insurance and asset management, both of which contributed to recurring revenue growth along with research and data feeds. We briefly discussed some of these businesses in the first quarter 2021 earnings call, and I want to further spotlight these two high-growth areas. I'll start by highlighting a few key trends in the KYC market. First, as I've mentioned before, the pandemic has accelerated digital transformation in know your customer and customer onboarding. Second, regulators are requiring organizations to know more about their customers and suppliers than ever before. And finally, financial crime continues to become more sophisticated, which requires advanced detection and monitoring capabilities. Our industry-leading product offerings and solutions leverage information on hundreds of millions of entities and ownership structures as well as detailed profiles on over 13 million politically exposed individuals. Using artificial intelligence, we combine our world-class data sets to map and analyze adverse media, together generating insights and identifying risks at a scale, speed, and precision that is difficult for others to match and creating a compelling solution that is unique to Moody's and enables our customers to make better and faster decisions to combat financial crime. Similar to our know your customer and financial crime compliance products, our expanding offerings for insurers and asset managers are contributing to revenue growth for MA and are a core part of our integrated risk assessment strategy. We initially entered the insurance customer segment by providing market-leading regulatory compliance software. We then moved into actuarial models to support global life insurers enabled by our acquisition of GGY. We further expanded our capabilities to include asset and liability management and balance sheet solutions, portfolio analytics and other tools to help address new accounting standards such as IFRS 17 and CECL. Now the data, analytics, and domain expertise from across our business enables us to provide insurers and asset managers with more comprehensive solutions to manage a wider set of risks. As the industry continues to evolve, our holistic approach allows us to build on our existing position in the insurance space, while at the same time provide a broader range of increasingly important analytics and insights, such as climate risk scenarios. Together, this has contributed to our ability to deliver 20% organic revenue growth over the trailing 12 months in this segment. And we're excited about the opportunity ahead to serve new and growing risk assessment use cases for insurers and asset managers, leveraging our vast data sets and analytic capabilities. I've also talked a number of times about the importance of innovating and integrating our data and analytics across our product suite. For example, this quarter, we launched an industry-first ESG Score Predictor. This offering combines Moody's ESG scoring methodology with company-specific data and predictive analytics to produce ESG scores for over 140 million small- and medium-sized enterprises. These scores allow our customers to screen ESG risks on public and private companies to monitor portfolio and supply chain risk and are a great example of integrating our SME and ESG capabilities to address a key market need, which is ESG assessment to support sustainable supply chains. Now staying on ESG for a moment, there's been a proliferation of climate-related financial disclosures over the past few years, and we recently partnered with the TCFD to provide insight on the quality of climate disclosures, leveraging our natural language processing and machine learning tools. In MIS, we expanded our proprietary ESG credit impact score coverage to companies in a broader range of industries as well as to U.S. states and cities. And we believe this is a unique offering that will allow investors to understand more clearly the impact of E, S, and G on any issuer's creditworthiness and enhances our credit ratings relevance and thought leadership. In MA, as a leading provider of know-your-customer data and analytics, our customers are increasingly needing to comply with regulations relating to modern slavery and human trafficking within their supply chains. Working with various stakeholders, we added new AI-enabled features to help our customers screen and track previously undetected instances of human trafficking and modern slavery risk across their supplier base, providing an opportunity to further broaden our KYC customer base beyond financial institutions. I'm frequently asked how we are differentiating ourselves in the ESG space. So I thought I would take a minute to provide a few customer case studies that illustrate how we're combining our capabilities to meet the risk assessment needs of different customer types. In the Americas, we worked with a leading global commercial real estate firm to embed physical climate risk analysis into their global funds and client portfolios. The detail and rigor of our climate scores and data on individual properties allowed them to analyze thousands of properties in a more sophisticated and efficient way. In Europe, a large government agency requested our expertise on their green bond financing framework. Through our second-party opinion, we assessed that the proposed framework not only aligned with their climate and environmental agenda but also with the 2021 green bond principles. Since 2012, we provided hundreds of second-party opinions across 30 countries with over 60 second-party opinions provided just in the first half of this year. On to Asia, a large regional bank, also an existing MA customer, recently selected Moody's to create a robust framework to quantify the ESG and climate risk of customers' portfolios, leveraging our ESG assessments, ESG and climate insights, and data and our ESG Score Predictor that I just talked about. They also requested in-house training on how to integrate ESG and sustainability into their in-house risk management practices. So it's a really great example of commercializing ESG and climate across our risk assessment offerings and our customer base. Before I turn it over to Mark, I also want to highlight a few examples of industry recognition that Moody's has received through the first half of this year. And these matter because they are independent third-party validation about the strength of our offerings across the firm. MIS was named Best Credit Rating Agency in multiple areas in the GlobalCapital Bond Awards and the Best Global Credit Rating Agency by Institutional Investor again. MIS was also ranked the #1 Securitization Rating Agency of the Year in the GlobalCapital European Awards. As I noted, within MA, we are investing in our products to help our customers make better decisions on a wider range of risks. Industry participants recognize the pace of our innovation, awarding MA's Credit Sentiment Score the Best AI-based Solution in the 2021 AI Breakthrough Awards. I'm pleased that we ranked #2 on Chartis' STORM Top 50, demonstrating our position at the forefront of digital transformation in our sector. Moody's ESG Solutions also won the Climate Risk Solution of the Year in Environmental Finance's Sustainable Investment Awards. I'm also enormously proud that Moody's was named a Top 50 Company for Diversity by DiversityInc. Together, these recognitions underscore our commitment to customer delivery, innovation, sustainability, and diversity, equity, and inclusion, all of which are critical to our sustained success. Finally, I'm thrilled that Moody's joined the Fortune 500 earlier this quarter. This milestone is a testament to the dedication our employees have shown both to our customers and to one another. On behalf of the executive team, I would like to thank all of our employees for their ongoing efforts which contribute to these great recognitions. With that, I'll now turn the call over to Mark to provide further details on Moody's second quarter results as well as an update to our outlook for 2021.

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 insurance and asset management offerings, tools supporting upcoming accounting standards implementations such as IFRS 17, as well as our SaaS-based credit assessment and origination solutions. Additionally, ERS' recurring revenue comprised 88% of second-quarter revenue, up 8 percentage points from the prior year period. MA's adjusted operating margin expanded 310 basis points to 31.8%. This reflected the benefits of our recently completed restructuring program, which relates to the realization of incremental operating leverage in the quarter. Turning to Moody's full year 2021 guidance. Moody's outlook for 2021 is based on assumptions regarding many geopolitical conditions, macroeconomic and capital market factors. These include, but are not limited to, the impact of the COVID-19 pandemic; responses by governments, regulators, businesses, and individuals as well as the effects on interest rates, foreign currency exchange rates, capital markets liquidity, and activity in different sectors of the debt market. The outlook also reflects assumptions regarding general economic conditions, the company's own operations and personnel as well as additional items detailed in the earnings release. Our full year 2021 guidance is underpinned by the following macro assumptions: a rise in the 2021 U.S. and euro area GDP to a range of 6% to 7% and 4% to 5%, respectively; benchmark interest rates will remain low, with U.S. high-yield spreads remaining below approximately 500 basis points; the U.S. unemployment rate will decline to under 5% by year-end; and the global high-yield default rate will fall below 2% by year-end. Our guidance also assumes foreign currency translation at end-of-quarter exchange rates. Specifically, our forecast for the balance of 2021 reflects U.S. exchange rates for the British pound of $1.38 and $1.19 for the euro. These assumptions are subject to uncertainties, and results for the year could differ materially from our current outlook. Following our better-than-anticipated second quarter results, we are raising our full-year 2021 guidance across several metrics. We now forecast Moody's revenue to grow in the low double-digit percent range. We maintain our expectation for expenses to increase in the mid-single-digit percent range as we balance reinvesting the benefits from our cost efficiency programs against the opportunity for future growth-oriented investments. Given our improved revenue outlook and expense stability, we now project Moody's adjusted operating margin to be approximately 51%. We raised the diluted and adjusted diluted EPS guidance ranges to $10.95 to $11.25 and $11.55 to $11.85, respectively. We increased our free cash flow forecast to be between $2.2 billion and $2.3 billion. And we anticipate full-year share repurchases to remain at approximately $1.5 billion, subject to available cash, market conditions, and other ongoing capital allocation. On prior earnings calls, Rob has detailed our integrated risk assessment strategy, of which investments and acquisitions will play an important role. To that end, we are focused on M&A opportunities in our addressable markets that will advance our strategy. As always, we don't comment on any specific potential acquisitions or divestitures, and we won't comment on any deals that we are pursuing. We have not included the impact of any future acquisitions in our current outlook, but obviously, a transaction could affect our guidance depending on the terms of any deals that we are able to reach. Under our long-held capital allocation policy, we prioritize organic and inorganic investments into the business before returning any excess cash via share repurchases. For a complete list of our guidance, please refer to Table 12 of our earnings release. Within MIS, following a strong second quarter, we now project aggregate global rated issuance to grow in the low single-digit percent range, up from our previous guidance of a low single-digit percent decline. We would like to reiterate that our guidance, similar to last quarter, does not factor in any potential impacts from the U.S. infrastructure bill proposals. We are raising our issuance forecast for leveraged loans to be up approximately 75% and for high-yield bonds to be up approximately 25%. These are meaningful increases compared to our prior outlook of up 55% and approximately flat, respectively, and is the result of better-than-expected second quarter issuance as well as ongoing favorable refinancing conditions and heightened M&A activity. We expect that the increase in leveraged loan supply will continue to drive CLO creation, and therefore, we are also improving the structured issuance outlook to be up approximately 75%. Following a very active 2020, full-year investment-grade supply is now forecast to decrease by approximately 40%. That's slightly lower than our previous guidance, which anticipated volumes to decline 30%. Also, after a surge in activity in the second quarter, we are increasing our guidance for new mandates to be in the range of 950 to 1,050. While we believe favorable market conditions will persist, we forecast issuance to moderate in the second half of the year to more of a historic sawtooth pattern as we believe many issuers will fulfill the majority of their funding needs early in the year and that liquidity-driven issuance will return to pre-pandemic levels. With our improved issuance outlook, we now estimate that MIS' revenue will increase in the high single-digit percent range. MIS' adjusted operating margin guidance remains at approximately 61% as our improved top-line outlook is partially offset by higher incentive compensation accruals and an acceleration in ESG, technology, and automation investments in the second half of the year. For MA, we are maintaining our low double-digit revenue growth guidance, supported by a high single-digit constant dollar organic growth given robust demand for our renewable products and stable customer retention rates, favorable movements in foreign exchange rates, and tailwinds from a recent acquisition. We are raising MA's adjusted operating margin guidance to be in the range of 30% to 31% as we continue to effectively manage our expense base while accelerating strategic investment back into the business. As I mentioned previously, we are reaffirming our full-year 2021 expense guidance to increase in the mid-single-digit percent range. Although we expect higher incentive compensation accruals associated with our improved revenue outlook, many of our cost efficiency initiatives and organic investment assumptions remain in line with our prior update. This enables us to both fund our strategic priorities and reinvest back into the business. Finally, we want to reiterate that our spending for key organic investments will be heavily weighted towards the second half of the year. Before turning the call back to Rob, I'd like to highlight a few key takeaways. First, we successfully executed our strategic and business objectives, delivering strong results again this quarter. Second, several areas of MA, specifically KYC and compliance, research and data feeds as well as insurance and asset management, provided momentum for recurring revenue growth. Third, we continue to integrate and embed our holistic E, S, and G offerings within our products and solutions, enabling our stakeholders to manage an evolving set of risks. Fourth, our culture of continuous expense discipline enabled us to purposely reinvest back into the business. Finally, following a robust first-half performance and the ongoing global economic recovery, we are pleased to be able to upwardly revise our 2021 financial outlook. With that, let me turn the call back over to Rob.

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

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 the second half will moderate, but are you assuming that Q3 continues kind of the run we've seen in Q2 and then Q4 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. Obviously, that's an improvement from our outlook for low single-digit decline earlier this year. That's 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. 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. 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. 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. 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, 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. 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 two 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, specifically for our SPO product, which has allowed us to drive success in that sustainable finance area. 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. 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, which allows us to integrate directly climate scenarios based on the network for the greening of the financial system into our banking and other EDF models. Lastly, there's 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. Most importantly, it allows customers to access more than 140 million ESG scores, which are then integrated into our existing Moody's products like Orbis, compliance, and 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 product development ongoing.

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. They would fit well with our industrial logic and could meaningfully accelerate our integrated risk assessment strategy by bringing in new capabilities or enhancing our current offerings and initiatives. Our outlook doesn't specifically include the impact of any future acquisitions. To the extent we commit spending to and are 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 strategic initiatives that are out there today.

Yes, Kevin, this is Rob. 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. 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.

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 the third quarter vis-a-vis fourth quarter related to expenses to support those activities.

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 Q2 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. 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 really reflects 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 it will be down in the low single-digit percent range, and that's really due to three 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, the acceleration of the strategic investments that we have into the second half of the year. 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 high single-digit organic revenue growth. We're 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 touching on each of these a little bit, to give you a sense of the demand and what's driving the growth, in KYC and compliance, there's this demand for greater precision and automation of customer vetting. There's emerging demand for understanding supply chain resiliency alongside that. So all of that is driving mid-20s growth in that KYC space. Credit research and data feeds have very high retention rates for that credit research, with lots of demand for the data feeds. That reinforces the critical nature of that content during times of market stress and uncertainty. I also called out on my opening remarks, inside of ERS are areas like insurance and asset management. We thought it was worth calling out this quarter. We have ongoing demand for the IFRS 17 solutions, but also increasing penetration of the buy side, defined benefit pension plans in the kind of risk technology and portfolio design space. All of this is coming together to help drive strong growth in that segment. We have a very active product development pipeline across all of MA, and we expect to continue to have opportunities to fill in product gaps and extend our capabilities to support ongoing growth.

I wanted to ask about the ERS business. We've had about three straight quarters of low single-digit growth. I know a lot of this is related to lower one-time sales. But I guess when does that fully get worked through? 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, which represented about 88% of total ERS revenue in the quarter. That's why we're so focused on that number. Recurring revenue in ERS was up 15% on an as-reported basis and something like 9% on an organic constant dollar basis. Looking at the drivers of that recurring revenue growth, we've had double-digit recurring revenue growth in both insurance and our risk and finance solutions. I talked a bit just a minute ago about what's driving growth in the insurance space. In risk and finance solutions, we've seen customers continue to leverage a range of different offerings that support credit loss reporting requirements and asset and liability and balance sheet management. Our recent acquisition of ZM Financial enhanced that. You're right that 15% recurring revenue is impressive, but overall revenue growth was 5%. The 15% recurring revenue growth was dampened by an almost 40% contraction in one-time business at ERS. As for one-time revenue, we've got increasing customer preference for SaaS solutions. This is naturally going to lead to a continued decline in our one-time revenue for the foreseeable future. That said, I expect the rate of decline for one-time 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 wanting on-prem solutions, and may service that. But I think you're going to see that decline decelerate and then level off sometime next year.

Maybe, Toni, just to add a couple of numbers, think about one-time revenue 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. This is obviously way below last year's margins, and last year included some nonrecurring items like severance and some extra incentive comp. I know you're building in more incentive comp in the second half. But just how should we think about the pacing of investment spend? How much of this is conservatism? What are the pieces there?

Sure. Our updated guidance for the full year 2021 MIS adjusted operating margin is approximately 61%. That's 130 basis points higher than the actual 2020 adjusted operating margin of 59.7%. Additionally, the MIS margin expanded by another 170 basis points in 2020. In Q2, we spoke about the primary drivers of our MIS margin, and what we’re seeing is partly flowing through to our full-year outlook. We see an increase in operating leverage above a normalized run rate, driven by better-than-expected issuance volumes and mix. This is underpinned by the expense discipline you're observing. It's important to keep in mind that we plan to deploy part of that operating leverage towards strategic investments in the second half to advance ESG capabilities, our technology stack, benefiting our customers. We expect those actions will bring down the third and fourth-quarter MIS margin, to your point, below the 61% we're guiding to for the full year. It's also worth noting that MIS is carrying additional incentive compensation accruals associated with the better-than-expected issuance that will reset in 2022. If we think about combining some of the one-time costs and incentive comp, the key point 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 what we might see in the second half.

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

Alex, it's Rob. Maybe let me talk a little about how we think about the upside and downside to issuance. You're right, it's been quite challenging to forecast for all of us. I might touch on the question around pull forward since 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. We've seen very strong activity in leveraged finance. I think that's a key in terms of how we're thinking about the second half of the year in terms of the issuance outlook. We anticipate some moderating of leveraged finance issuance in the second half of the year, as I said earlier, from the strong levels we've seen in the first half. So 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. There is also potential impact in 2021 from a bipartisan agreement around an infrastructure bill, likely yielding positive impact on issuance in 2022. Of course, I must note any escalation of infections or restrictions due to the Delta variant, could impact markets negatively. Increased equity market volatility is something we'll monitor since leveraged finance activity is often correlated to equity market conditions. So that's something we need to watch, along with any market disruptions due to unexpected 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, particularly the comment around larger bolt-ons. I would love for you to define that a little 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 how big something like this could be and what capacity you have? 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 with smaller deals and accelerated them, but if you're talking about larger bolt-ons, does this also need to accelerate top line growth or is a lot of accretion something that you care about? Maybe just remind us, I mean, you have an M&A history yourself, what do you look for financially?

So Alex, maybe I'll first clarify what I think of and what Mark means when we say larger bolt-on. I consider our acquisitions of RDC and Bureau van Dijk as larger bolt-on deals. We've received multiple questions about M&A over the last couple of quarters, and I refer everybody back to that. We're focused on M&A opportunities in our addressable markets that are on strategy and that will advance our risk assessment capabilities to better serve our customers' evolving needs. We've made acquisitions of high-value data and analytics critical to customer workflows and risk processes. They end up having high retention rates because we’ve been clear about the areas where we're investing and building scale businesses. Within KYC and financial crime, we've made significant investments and as a result, hold a strong position in that market. Private company data, CRE data, and analytics for commercial real estate is another area we see a large end market and demand from our customers, and the same is true for ESG and climate. Climate, in particular, is an area of near-term demand to understand physical risk related to climate change from our customers. Within our ERS business, we see further opportunities to continue to build out more comprehensive offerings for banks and expand our capabilities for insurance companies. You saw us do that with a very small acquisition of ZM Financial, which we’re doing both organically and inorganically.

From a capacity perspective, we continue to anchor our capital allocation and cash positioning policies around that BBB+ rating. 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.

Could you please give us an update on the strategy and outlook of your business in China? There are some news recently coming out from China. Could you please talk about if there is any 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 several developments occurring in China. One of them, I think you may refer to is the data security law. I would say as an integrated risk assessment business, policy developments, including those on data security, are very important factors we consider for China and elsewhere, and the impact on Moody's and our customers. A little background for everyone, China passed a new data security law in early June, effective in September. This law has some requirements around the localization of data and data transfer beyond China. I don't think that it will impact our ratings business, but it has a broad scope, meaning it could affect other parts of our business and our customers and suppliers over time. The impact is conditional on regulations being interpreted by the market and implemented by authorities. Regarding our long-term strategy in China, I don't think it changes it at this point. Mark, anything to add?

Yes. I would also note that regulators in both the exchange and the interbank markets amended policies to remove the mandatory bond rating requirements on non-financial bonds over the past couple of months, along with the mandatory requirement for disclosure of credit rating reports for public issuance. Those regulatory changes may have a short-term negative impact on domestic CRA revenue; however, they are positive from a 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, especially 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 will these investments increase the stickiness of your products? What I'm trying to understand is better ROI of these expenses.

Yes, look, both, I think is the answer. We're certainly enhancing existing products as we roll out new offerings. Let me touch on commercial real estate to give you a sense of what we're doing, as it's a major asset class for our financial institution and investor customers. We wanted to build out our capabilities in this area. Investors are looking for integration of a range of data and insights for better decisions, especially given the rapidly evolving asset class. Our investing and lending workflows have historically been fragmented and manual, which became particularly challenging amidst COVID stress. We made an acquisition a few years ago for market and property data, and now we are investing in lending and investing decision-making support. There's quite a bit of internal product build in addition to the acquisition earlier in the year for more listings data. You will see an expansion of our product array in these areas, along with enhancements of existing products.

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. To address that, we're doing a number of things, including updating our market benchmarking to ensure we're compensating our employees competitively and fairly. Importantly, this also includes workplace flexibility. Our employees and prospective employees have made it very clear that workplace flexibility is crucial to their decision to either stay or join a firm. We see our flexible approach as a competitive advantage compared to some financial institutions that have mandated five days back in the office. Our employees value diversity, equity, and inclusion, so they can be their authentic selves and be at their best. We've prioritized initiatives to support DE&I, and our employees resonate with our mission to provide clarity, knowledge, and fairness to an interconnected world.

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 on what the cadence should be in Q3 and Q4?

Yes, certainly, I'm happy to provide 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. This is driven by the historical issuance sawtooth pattern, with Q3 down mid-single digits against guidance and maybe up mid-single digits based on guidance in Q4. 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, factoring in our accelerated strategic organic investments we mentioned earlier.

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

Sure. Just to clarify my earlier question on costs specifically related to MIS, you should expect next year to look more like the first half of this year, 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. 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. As a point of reference, that will be lower than the actual incentive comp accruals from the third and fourth quarters of 2020.

My other question I want to ask is 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?

Yes, Craig. Let me start by talking about structured finance in the quarter and then share our outlook. Our second-quarter structured finance revenue in MIS was up almost 75%. Securitization activity across the board was very elevated, as mentioned, especially in CLOs, driven mainly by refinancing activity amidst an increase in leveraged loan supply. CMBS, which ground to a halt last year, has rebounded due to commercial real estate CLO transactions. We saw spreads tighten, so issuers who were on the sidelines returned. U.S. ABS and RMBS activity are currently at the highest levels seen in eight quarters. Overall issuance in RMBS remains strong, and spreads are still tight. There's been some recent widening due to supply, but not particularly material. Based on discussions with bankers, we don't see signs of slowing down. ABS fundamentals are expected to continue to improve, with significant pent-up demand and overall economic activity contributing to our updated outlook on structured finance issuance for the year.

I 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 the Climate Solutions 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. Then whether or not you have an opinion on how the consumers of those products might evolve over time. To the extent that this would expand the addressable market for that business?

Sure. The market for these ESG products started with investors focused on socially responsible investing, which has mainstreamed to equity and fixed income investors globally who want ESG content for portfolio construction and monitoring. The customer base is broadening out to all our customer types, which includes not only investors but also financial institutions, corporates, and governments. A key theme is the demand for integration of ESG into a wide range of customer processes, from portfolio monitoring to corporate sustainable finance to understanding ESG and climate risks of borrowers by banks. Governments want to mitigate risk and invest related to the physical risk from climate change. That's why we talk about integration across our product suite.

Perfect. That's really helpful. I wanted to ask about some of Moody's-specific ESG initiatives underway and progress since it's 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're very well positioned to help answer ESG-related questions for the business and to bring transparency to equity and fixed income and the sustainability markets more broadly. Let me touch on a couple of areas of interest. 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. We've built a combination of technology-enabled scoring and analytical overlays for the assessments we deliver to provide reliable, high-quality insights for our customers. Another area where we excel is on physical risk assessment for climate, whether looking at asset-level data on exposure to flood, heat, stress, hurricanes, and so forth, as well as supply chain risk. Finally, our strong sustainable ratings presence speaks to our active engagement in the first and second quarter for our insights on our products. Integrating these into our MA product suite also serves as a differentiator for us, and we hear from clients that they need tailor-made solutions with access to ESG analytics alongside our subject matter experts.

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 have 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 private company data.

Good to have you on the call. You're right that the biggest and fastest-growing use case for private company data is around know your customer. As I mentioned earlier, we're starting to see emerging demand for addressing supply chain risks. That said, our private company data fuels a whole range of use cases; take tax and transfer pricing, trade credit, master data management, digital marketing, and corporate development as examples. We’re seeing good growth across the entire portfolio. Additionally, we are integrating that data into many of our offerings. For commercial real estate, for instance, customers want a more holistic understanding of properties they're investing in or lending on. A key point is understanding the profile of the tenants in those buildings, and we can leverage our data to better inform those strategies.

That's very helpful. I just 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 is there to upsell and cross-sell into your existing customer base?

Ashish, are you specifically speaking about insurance? Do I have that right?

Yes, insurance and asset management or if you want to talk in generalities also about how well the offerings are penetrated and how much more room there is for upsell and cross-sell without necessarily going after new logos.

Yes. I guess maybe I'd start by highlighting that our current insurance franchise is primarily focused on life insurance. There are synergies between life insurance and asset management on the buy-side. We've been able to expand product offerings by leveraging our combined capabilities. We've seen insurance customers take one product, increasing opportunities to cross-sell multiple products. We started with regulatory compliance reporting, like Solvency II, then evolved into actuarial modeling and developed products around IFRS 17 and CECL. This creates land-and-expand strategies where insurance companies take our existing products and increasingly want multiple offerings.

I want to circle back to some questions that were asked before, especially on Owen's question about what's going on in China right now. The media is reporting and characterizing it as some sort of crackdown risk. It's more than just specific laws about data privacy in terms of a tight regulatory environment emerging. How do you think about that context with your business, both operationally in China and from a ratings perspective in terms of rating various businesses out there and how these changes in the regulatory environment might alter your recommendations?

Yes. Certainly, it's an evolving landscape, and we must navigate these changes. Given the atmospherics in U.S.-Sino relations, I will discuss our approach to the domestic rating market since we get a lot of queries about this on our calls and from investors. I'm comfortable with our approach to the domestic ratings market, which is to work through leading Chinese players because I think it is challenging for wholly-owned American companies to achieve leadership in nationally important industries in China in the medium and long term. What's happening today confirms that view. In regard to the U.S. government's recent business advisory related to U.S. companies operating in Hong Kong, I want to note that Hong Kong is a critical business hub. Regarding that advisory's substance, we have contingency plans for business issues in all our offices worldwide, and Hong Kong is no different.

Yes, to also note that the regulators in both the exchange and the interbank markets amended policies to remove the mandatory bond rating requirements on non-financial 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 from that medium to long-term perspective in transforming the regulatory demand for ratings into more sustainable market or investor-driven demand.

Okay. And then just going back to some of the questions regarding ERS, how much of it is still being impacted by the ability of your people to go over to clients and meet face-to-face? I know there was a lag because of clients not being able to meet physically with implementers. I was wondering how much you're still being impacted and whether you're seeing a change in momentum recently?

Yes, we talked about this during the pandemic regarding big implementations. The on-prem solutions, which were more significantly affected, are now a smaller part of our business. However, we adapted well to virtual engagement with our customers. You'll see that reflected not only in the recurring revenue growth, but in our sales of SaaS solutions as well. The decline in onetime revenue reflects part of that shift. But overall, our success in adapting to virtual engagement has been strong.

Can I sneak in one more?

Please, Shlomo, go ahead.

It's just a quick one. Cortera, it looks like you 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 we've done, we feel comfortable that the pace we're executing at makes a lot of sense for our business and the direction we're going. I'd be comfortable for you to assume that level. Widening the aperture a little, for the year, we're looking for the 2021 M&A impact on our revenue number, inclusive of Cortera but excluding RDC, to be around $44 million for the full year.

That’s a small part of our overall data solutions business, and increasingly that data will be integrated into various products. We're focusing on the broader data solutions business rather than individual results.

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, particularly the credit rating agency industry. What's the current nature of your dialogue with the SEC and the Biden administration? Are you incrementally more concerned about potentially disruptive regulations?

Patrick, thanks for the question. As you expect, we have an active dialogue with our regulators and policymakers in the U.S. and around the world. From time to time, our business model becomes a topic of discussion and has been studied in various jurisdictions over the past decade. In 2020, there was an SEC advisory group that represented a broad market cross-section, and the conclusions have remained the same: allowing for a variety of business models enables the market to function efficiently. Over the past decade, policymakers have strengthened the regulatory framework around our industry, and we, as a company and industry, have enhanced processes and internal controls to manage conflicts of interest and provide high confidence and transparency for the market. We operate under a robust regulatory oversight regime. We’ll continue focusing on maintaining compliance and providing the market with independent, transparent credit ratings of the highest quality. Over the past 18 months, I’ve met with numerous issuers, investors, policymakers, and regulators, and I believe there is general feedback that we managed ratings effectively during the pandemic, which I think is a testament to the credit rating agency industry.

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 lowered. What is happening over there to change that outlook?

Maybe I'll start with some context. MA is focused on top-line renewable growth through organic strategic investments, given the large opportunity set available while concurrently looking to ensure margin expansion and profitability. Historically, we've achieved nearly 500 basis points of expansion since 2017. We raised our MA fully allocated adjusted operating margin guidance to 30% to 31%, which is 60 to 160 basis points higher than the 2020 actual of 29.4%. The core margin expansion will increase by approximately 230 basis points, offset by M&A and organic investments of around 140 basis points, guiding to a midpoint of 120 basis points. We see strong leverage occurring in the fill year guidance.

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? What about T&E expenses? Is it sort of like a $100 million rough number that will come back versus what we're tracking at right now?

So Craig, maybe a bit of context and then I'll address your specific question. The management team is pleased to highlight that disciplined expense management continues to create and maintain operating leverage and investment capacity for our business. As an interesting comparison, if I discuss the first half of the year versus the second half, we saw operating expenses effectively up 5% year-over-year. This 5% within the first half includes operating expenses, excluding M&A and FX, were flat. The reason for this includes the 2020 real estate rationalization program, savings from the 2020 MA restructuring plan that ended this quarter, and cost savings from initiatives for offshoring. If we think about expenses, excluding M&A and FX, the second half is ramping up as we mentioned about that mid-single-digit directive. T&E for the year is probably around 1/4 of what it was in 2019. A portion of that will come back, but we expect a lot of the business-wise efficiencies will persist.

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.