Good day, ladies and gentlemen. Welcome to the Moody's Corporation second quarter 2016 earnings conference call. At this time, I'd like to inform you that this conference is being recorded, and that all participants are in a listen-only mode. At the request of the company, we will open the conference up for questions and answers following the presentation. I will now turn the conference over to Salli Schwartz, Global Head of Investor Relations and Communications. Please go ahead, ma'am.
Thank you. Good morning, everyone, and thanks for joining us on this teleconference to discuss Moody's second quarter 2016 results, as well as our current outlook for full year 2016. I am Salli Schwartz, Global Head of Investor Relations and Communications. This morning, Moody's released its results for the second quarter of 2016, as well as our current outlook for full year 2016. The earnings press release and a presentation to accompany this teleconference are both available on our website at ir.moodys.com. Raymond McDaniel, Moody's President and Chief Executive Officer, will lead this morning's conference call. Also making prepared remarks on the call this morning is Linda Huber, Moody's Executive Vice President and Chief Financial Officer. Before we begin, I call your attention to the safe harbor language, which can be found toward 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 31st, 2015, and in other SEC filings made by the company, which are available on our website and on the Securities and Exchange Commission'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'll now turn the call over to Raymond McDaniel.
Thanks, Salli. Good morning, and thank you to everyone for joining today's call. I'll begin by summarizing Moody's second quarter and year-to-date 2016 results. Linda will follow with additional financial detail and operating highlights. I will conclude with comments on our current outlook for 2016. After our prepared remarks, we'll be happy to respond to your questions. In the second quarter, Moody's revenue of $929 million increased 1% from the second quarter of 2015, despite a challenging year-on-year comparable. Moody's Analytics delivered its 34th consecutive quarter of revenue growth, while Moody's Investors Service attained its second highest quarterly revenue ever, only surpassed by its performance in the same period last year. Operating expense for the second quarter was $519 million, up 4% from the second quarter of 2015. Operating income was $410 million, a 2% decline from the prior year period.
Foreign currency translation favorably impacted operating income by 1%. Adjusted operating income, defined as operating income before depreciation and amortization, was $441 million, down 1% from the same period last year. Operating margin for the second quarter of 2016 was 44.2%. The adjusted operating margin was 47.5%. Diluted earnings per share of $1.30 was up 2% from the prior year period. Turning to year-to-date performance, Moody's revenue for the first half of 2016 was $1.7 billion, a decline of 2% from the prior year period. Excluding the impact of foreign currency translation, revenue declined 1%. Revenue at Moody's Investors Service was $1.2 billion, a decline of 7% from 2015. Revenue at Moody's Analytics was $594 million, 10% higher than the prior year period. Operating expense in the first half of 2016 was $1 billion, up 4% from the prior period.
Excluding the impact of foreign currency translation, operating expense was up 6%. Operating income was $714 million, down 10% from the first half of 2015. The impact of foreign currency translation was negligible. Adjusted operating income of $775 million was down 8% from the prior year period. Moody's reported operating margin was 40.9%, and its adjusted operating margin was 44.4%. The effective tax rate for the first half of 2016 was 32.1%, up from 31.5% from the prior year period. Despite a good second quarter, we have modestly reduced certain elements of our revenue guidance due to our more cautious outlook for issuance outside the U.S. following the British referendum to leave the European Union and the expected negative impact of foreign currency translation. As a result, we expect to be at the lower end of our $4.55 to $4.65 EPS guidance range.
I'll now turn the call over to Linda to provide further commentary on our financial results and other updates.
Thanks, Ray. I'll begin with revenue at the company level. As Ray mentioned, Moody's total revenue for the second quarter was $929 million, up 1% from the prior year period. U.S. revenue of $546 million was flat to the second quarter of 2015. Non-U.S. revenue of $383 million was up 3% and represented 41% of Moody's total revenue. The impact of foreign currency translation on MCO revenue was negligible. Recurring revenue of $467 million was up 6% and represented 50% of total revenue.
Looking now at each of our businesses, starting with Moody's Investors Service, total MIS revenue for the quarter was $626 million, down 2% from the prior year period, but up 19% from the first quarter. U.S. revenue declined 3% to $399 million, while non-U.S. revenue of $227 million was flat to the prior period and represented 36% of total ratings revenue. The impact of foreign currency translation on MIS revenue was negligible. Moving to the lines of business for MIS. First, global corporate finance revenue of $305 million in the second quarter was down 5% from the prior year period. This result primarily reflected lower levels of U.S. speculative grade and Asian investment-grade issuance despite increased activity from the first quarter. U.S. and non-U.S. corporate finance revenues were down 4% and 6%, respectively.
Second, global structured finance revenue for the second quarter was $112 million, down 8% from the prior year period, as reduced U.S. CLO and CMBS activity was only partially offset by increased European structured finance activity. U.S. structured finance revenue was down 16%, while non-U.S. revenue was up 14%. Third, global financial institutions revenue of $90 million was down 1% from the prior year period. U.S. financial institutions revenue was up 7%, while non-U.S. revenue was down 7%. Fourth, global public project and infrastructure finance revenue of $112 million was up 12% versus the prior year period, primarily as a result of increased global infrastructure-related issuance. U.S. and non-U.S. public project and infrastructure finance revenues were up 11% and 16%, respectively.
MIS other, which consists of non-rating revenues from ICRA in India and Korea Investors Service, contributed $7 million to MIS revenue for the second quarter, down 10% from the prior year period. Turning now to Moody's Analytics. Global revenue for MA of $303 million was up 9% from the second quarter of 2015. U.S. revenue of $147 million was up 10% year over year. Non-U.S. revenue of $156 million was up 8% and represented 52% of total MA revenue. Foreign currency translation unfavorably impacted MA revenue by 1%. Excluding revenue from our March 2016 acquisition of GGY, MA revenue grew 6%. Moving now to the lines of business for MA. First, global research data and analytics, or RD&A, revenue of $168 million was up 7% from the prior year period and represented 55% of total MA revenue.
Growth was mainly due to strength in the sales of credit research and rating data feeds. U.S. and non-U.S. RD&A revenues were each up 7%. Second, global enterprise risk solutions, or ERS, revenue of $98 million was up 17% from last year. The growth was driven primarily by the acquisition of GGY as well as growth across all product lines with particular strength from regulatory and risk measurement product revenues. U.S. and non-U.S. ERS revenues were up 21% and 15%, respectively. Trailing 12-month revenue and sales for ERS increased 11% and 6%, respectively. As we've noted in the past, due to the variable nature of project timing and completion, ERS revenue and sales remain subject to quarterly volatility. Third, global professional services revenue of $38 million was down 2% from the prior year period.
This result was primarily due to the impact of customer attrition identified last year, as well as the unfavorable impact of foreign exchange on the credentials and licensing business. U.S. professional services revenue was flat to the prior year period, while non-U.S. revenue was down 3%. Turning now to expense. Moody's second quarter expense was $519 million, up 4% from 2015. The increase was primarily due to higher compensation costs in MA, reflecting additional headcount to support business growth and the acquisition of GGY. MIS expense was down slightly compared to the prior year period. Foreign currency translation favorably impacted expense by 2%. As Ray noted, Moody's reported operating margin and adjusted operating margin were 44.2% and 47.5%, respectively, for the second quarter. Moody's effective tax rate for the quarter was 31.9%, up from 30.4% in the second quarter of 2015. Now I'll provide an update on capital allocation.
During the second quarter of 2016, Moody's repurchased 2.3 million shares at a total cost of $224 million, or an average cost of $96.60 per share, and issued 249,000 shares as part of its employee stock compensation, stock-based compensation plan. Moody's also paid $72 million in dividends during the quarter, and on July 12th, announced quarterly dividend of $0.37 per share of Moody's common stock, payable September 12th to stockholders of record at the close of business on August 22nd. Over the first half of 2016, Moody's repurchased 5.2 million shares at a total cost of $486 million, or an average cost of $92.83 per share. The company also returned $144 million to its shareholders via dividend payments during this same period. Outstanding shares as of June 30th, 2016, totaled 192 million, down 4% from June 30th, 2015.
As of June 30th, 2016, Moody's had $1 billion of share repurchase authority remaining. At quarter end, Moody's had $3.4 billion of outstanding debt and $1 billion of additional debt capacity available under its revolving credit facility. Total cash equivalents, and short-term investments at quarter end were $2 billion, with approximately 78% held outside the U.S. Free cash flow in the first six months of 2016 was $475 million, down 14% from the first six months of 2015, primarily due to lower net income. With that, I'll turn the call back over to Ray.
Thanks, Linda. I'll conclude this morning's prepared comments by discussing changes to our full-year guidance for 2016. A full list of Moody's guidance is included in our second quarter 2016 earnings press release, which can be found on the Moody's Investor Relations website at ir.moodys.com. Moody's current outlook for 2016 is based on assumptions about many geopolitical conditions and macroeconomic and capital market factors, including interest rates, foreign currency exchange rates, corporate profitability, business investment spending, mergers and acquisitions, consumer borrowing and securitization, and the amount of debt issued. These assumptions are subject to uncertainty, and results for the full year could differ materially from our current outlook. Our guidance assumes foreign currency translation at end-of-quarter exchange rates. Specifically, our forecast reflects exchange rates for the British pound of $1.34 to GBP 1 British, and for the euro of $1.11 to EUR 1.
Based on our current business mix, the annualized impact of a EUR 0.01 decline in the euro against the U.S. dollar equals approximately a $0.01 decline in our annualized EPS. On the other hand, a GBP 0.01 decline in the British pound against the U.S. dollar has a minimal impact to EPS. As I noted earlier, Moody's is reaffirming our full-year 2016 EPS guidance of $4.55 to $4.65, and expects to be toward the lower end of the range. Moody's full-year 2016 revenue is still expected to increase in the low single-digit % range. Moody's operating expense is still expected to increase in the mid-single digit % range. For MIS, Moody's now expects 2016 revenue to decrease in the low single-digit % range, reflecting reduced guidance for our non-U.S. MIS revenue, which we now also expect to decrease in the low single-digit % range.
U.S. revenue is still expected to decrease in the low single-digit % range. Structured finance revenue is now expected to decrease in the high single-digit % range. For MA, 2016 revenue is now expected to increase in the mid-single digit % range. U.S. revenue is still expected to increase in the low double-digit % range, while non-U.S. revenue is now expected to increase in the low single-digit % range. Before we move to the Q&A, I would like to highlight three items, including investment we made earlier this week in Korea, an award won by MIS, and the launch of a new MA product. On Monday, Moody's announced it has acquired full ownership of Korea Investors Service, or KIS, a leading provider of domestic credit ratings in Korea. Moody's and KIS have had a long-standing and productive relationship since 2001.
We believe that an even closer partnership and continued investment in the business will enable us to capitalize on the opportunities for growth and better serve the market in Korea. The acquisition is not expected to have a significant impact on Moody's earnings per share for 2016 and has been funded from international cash on hand. Additionally, MIS was voted best credit rating agency in a 2016 poll of U.S. fixed income investors conducted by the publisher Institutional Investor. This is the fifth year in a row that MIS has won this award. I appreciate the market's recognition of our efforts, and I applaud the accomplishments of our MIS colleagues. Finally, yesterday, we announced the launch of Moody's Analytics Risk Quality Score, or MARQ, a tool to help private companies understand their credit profile and support bank lending to small businesses.
The MARQ Score and the related web portal are a result of our collaboration with Finagraph, a financial technology company in which we made a minority investment earlier this year. This concludes our prepared remarks, and joining Linda and me for the question and answer session are Mark Almeida, President of Moody's Analytics, and Rob Fauber, President of Moody's Investors Service. We'd be pleased to take any questions that you might have.
Thank you. Ladies and gentlemen, if you'd like to ask a question, please press star one on your telephone keypad. If you're on a speakerphone, please pick up your handset and make sure your mute function has been turned off to allow your signal to reach our equipment. Once again, that's star one. We'll go first to Alex Kramm with UBS.
Okay. Hello, everyone. Just coming back to your guidance for a minute here. Going through the earning cycle for the banks based on a fairly constructive on DCM, rates have trended lower or are low. Credit spreads are still pretty reasonable, and I guess we're getting pretty close to the refi pipeline here. Just wondering, with everything seemingly looking a little bit better, at least from our seats, where are you seeing that incremental weakness to make you more conservative? If there's anything else you can add, that would be great.
Sure. As we said in the prepared remarks, it's really uncertainty about international issuance activity that's driving a somewhat more cautious outlook. I would ask to add that since the Brexit vote on June 23rd, we haven't seen much activity in international issuance. Average daily issuance volumes are down in really all key markets except for U.S. investment grade. That being said, the timing of the vote does coincide with a seasonal decline in issuance that we typically see in July and August, especially again in the euro market.
Trying to assess at this point the decrease in issuance as a result of uncertainty about the leave vote versus normal seasonal factors actually is a bit difficult. Hopefully we are being more cautious than we need to be, but that's what's influencing our thinking. We also think it's going to have an impact outside the corporate sector in structured finance. That's really what's informing our views at this point.
Alex, I'll go through the normal views on each of the segments that we talk about, then I'll ask Rob Fauber to comment a little bit further on your question. We'll put up now the slide that talks about our usual views from investment banks and capital markets economists. The points here cover both financial and non-financial U.S. dollar issuance, and their ways of counting things may not align with our revenue categorization. Looking at U.S. investment grade, the market has been quite resilient post-Brexit. All-in yields are below previous record lows. The 10-year's at 1.59 this morning, and spreads are quite attractive. M&A-related financing continues to be a strong driver. Favorable market conditions are expected to encourage opportunistic issuance post-earnings blackout. As Ray said, this is typically a slow period. Full-year estimated issuance forecasts range from flat to up 10%.
High yield new issuance in Q2 was the strongest it's been in a year, we expected to see that given that the Brexit situation had backed up that market a bit. We expect as we move forward in the year that issuance windows may be shorter. Again, the risk on, risk off phenomenon. Full-year issuance forecasts range from down 10% to down 20%. Leverage loans, we're pleased to see CLO issuance has started to reemerge. $30 billion of issuance in CLOs year to date. The pipeline is categorized as modest and full year 2016 estimated issuance forecasts range from down 10% to down 20%. Looking at Europe, record low coupons as the ECB's corporate buying program continues to help the market and keep yields low. U.S. corporates are seeing value in moving to Europe, and we expect that to continue throughout the rest of the year.
Supply slowed as we've entered the traditional summer period, and many issuers came to the market before the Brexit vote on June 23rd. European high yield, the market's reopened after a period of muted issuance following the Brexit vote. Again, issuance windows are going to be shorter due to the macroeconomic view and the summer slowdown. Investors are moving down to speculative-grade securities to search for yield, given the low prevailing yield climate right at the moment. With that backdrop, I'll ask Rob if he wants to speak a little bit further about how we came to this view on MIS's components of guidance. Rob?
Yeah, thanks, Ray and Linda. I think that covers it well. The only thing I would add to that, as Linda said, we've seen a rebound post-Brexit vote. We went a couple of weeks where we had very little issuance. The first activity we saw was in the U.S. investment-grade market. We saw the Teva deal very well received recently. We've seen a pickup then in the U.S. high yield European investment-grade markets. This week, as Linda mentioned, we've seen some activity in the European high-yield market. We have resumed issuance activity. I would say we just balance that with, as Linda said, the potential for some headline risk and these risk on, risk off windows as we go through the year. I think the greatest sensitivity to those windows will be in European leverage finance.
All right, great. Thanks for the lengthy answer. Just one more real quick, since you mentioned Brexit several times here. Just wondering how you're thinking about the Brexit impact when you think about your business right now. Is this just like, well, the Eurozone is going to be in a little bit of a maybe slower growth environment? Or are there particular technicalities that you need to think about, like is the market structurally different post-Brexit, or will it be when we actually finally get there? What do you think in terms of your business, in terms of moving people around or anything that you might have to change on your end? Thanks.
Yeah. I think we're anticipating what you might characterize as a soft landing. There's still going to be some structural change even with a soft landing. We're not anticipating significant contagion effect throughout the rest of the EU or the Eurozone. We do recognize that assuming Brexit moves forward, and we are assuming it will, that there are going to have to be negotiations as far as the depth of participation of the U.K. in the European market. That's going to affect really a number of firms, particularly in the financial services, financial institution sector. We will make appropriate decisions for ourselves and for Moody's as decisions are being made in terms of the nature of the U.K.'s participation in the European economy on a going-forward basis. We really can't do anything until we see some more clarity around those decisions.
We are obviously attentive and we are preparing for a variety of outcomes, but nothing that I would say is on the near-term horizon in terms of changes in our business or how we are approaching the business in Europe.
Fantastic. Thank you very much.
Thank you. Our next question comes from Tim McHugh with William Blair.
Thanks. I guess just wanted to know if you could talk a little bit more, maybe Linda or Ray, I guess, on the expense management. You had talked about $50 million of adjustments you made last quarter. Can you talk about there, and then also just with Moody's Analytics, can you elaborate what the higher compensation or kind of additional staff exactly, I guess, what type of staff? Is it R&D, salespeople? I guess what they're investing in.
Yeah, I'll let Linda tackle the expense question. Maybe we can turn it over to Mark on the MA side.
Sure. Tim, this is a little tricky to follow. Let me try to lay this out, and I'm going to need a paragraph or two here to explain this appropriately. Last quarter, we told you we'd lowered our projected base business spending for the year by about $50 million, and we commented on that that had come from expense management actions and reduced incentive compensation. That was $50 million in reduction, which was great. Those savings were entirely offset by the addition of the GGY acquisition's operating expenses and the negative impact of foreign currency translation. We were down $50. $50 came back from GGY and FX. Now, since last quarter, we've done better with our cost savings than we thought we would. Additionally, we expect less negative impact from FX.
While we still have the partial offset from adding GGY's expenses, we now think we're going to be about $20 million in lower expenses versus the zero net impact before. We continue to work on this. We're very committed to ensuring that our expenses are in the right place. Again, the nature of the company is that we can't reduce things immediately given a more challenging revenue quarter like we had in the first quarter. We do think we've made good progress on bending the curve and moving the run rate, which we'll continue to show you, but probably more heavily in the fourth quarter than the third quarter. Hope that's thorough enough for you, and sorry it's not a particularly simple explanation. Does that work for you, Tim?
Yeah, that's great.
Okay.
Mark.
Sure. Yeah, a couple of things, Tim. First, we added a number of people as a result of the GGY acquisition. That's the lion's share of the headcount adds that we've had thus far this year. We continue to add to support the growth in the business. We've added some additional sales capacity. We're continuing to do that. We've also added some software engineers and product development people because we've got a number of new product development initiatives underway that will be coming to market as we move into next year. I would characterize other than the GGY adds, kind of business as usual as we continue to build out the business.
Okay, just a follow-up, Mark, as long as I have you. The new sales-type activity for the ERS business, I know you guys give the trailing 12 months number of 6%, I think similar to last quarter, you've got a pretty tough comp somewhere in that trailing 12 months. Kind of the new pace of activity, can you give us any sort of color in terms of how the trend line is?
Yeah, I'd say the trend is good. It's consistent with our expectations. I think the difference we're seeing this year compared with where we were in the first half of last year is that last year, early in the year, we had an unusually large number of very large transactions, multimillion-dollar transactions. We had a number of those. We haven't seen a similar number of similarly large transactions this year. The pace of closing contracts continues to be quite good, the average size of the contracts is smaller just because of the absence of some of those very outsized deals that we did last year. The pipeline is very healthy and again, consistent with our expectations. We feel good about where we are.
Is there any change in the market that explains the lack of the larger deals, or is it just the timing?
I think it's idiosyncratic to customers and specific situations. I don't think there's anything fundamentally different about the market or demand for what we're doing. I think the unusual thing, frankly, is what we saw in the early part of last year and just having a number of very large transactions. It's typical for us to get a very big multimillion-dollar, sort of north of $5 million deal from time to time. We just had a big concentration of those last year.
Okay, thank you.
Sure.
Thank you. Our next question comes from Manav Patnaik with Barclays.
Yeah, thank you. Good afternoon. Linda, just to close the loop on the expense update. Should we think about that incremental $20 million? I guess what I'm trying to get to is last quarter, you gave us that ramp from first quarter to fourth quarter. Should that just be $20 million less then?
Manav, let me talk to you a little bit about the ramp because we do have an update on that. We had said $35 million to $45 million ramp for 2016. That was from Q1 to Q4, as I said. We now expect the ramp to be lower from $25 million to $35 million. That's the result of reduced cost savings, lower bonus funding, and favorable FX. Excuse me.
Okay. Fair enough. You explained the international situation and the potential uncertainty there. I guess I just wanted to revisit the structured side of the market a bit. I think last quarter, you guys posed the question on whether maybe this was structural or cyclical. I was just wondering if you guys had any updated thoughts on where the structured market sits there today.
Yeah. I'll let Rob comment on this in more detail. As we observed earlier in the year, we think a lot of what's happening in structured market is cyclical, but there are some elements that could be structural, depending on how market participants sort out the economics of some asset classes as the risk retention rules change. Also we had a strong second quarter in structured in Europe, we will have to see how that plays out in the second half of the year because some of that strength was concentrated in the U.K. mortgage sector. We'll have to see how that sector responds to what's been happening on the political side. I don't know if Rob has anything else he wants to add on that.
Yeah, Ray, I agree with that, I think we did see a significant uptick in activity in the second quarter relative to the first quarter. In CMBS, in addition to sorting out some of the risk retention issues, I think there was a slowdown in conduit lending earlier in the year that dampened the pipeline a bit. That'll be supported on an ongoing basis by the refi wall, I think a regulatory focus by the banks on bank commercial real estate exposures. CLO, we saw very strong activity towards the end of the quarter, supported by more availability of newly issued loans in the United States, we do think we saw some Brexit pull forward. I think the pipeline may moderate a little bit going forward.
Overall, I think, we are seeing that the market is trying to work through some of these risk retention requirements, I think we'll see that in the back half of the year.
Okay. Just one more from me. Maybe I haven't noticed before, I guess, pointing out new product introduction, the MARQ Score that you referred to. How should we think about, is that a big market opportunity or was that just a policy? I'm not sure. I'm just trying to understand if there's something we should think about in terms of that launch.
No, it's not that it's an outsized opportunity that we're anticipating. Really, it's one of the early results of our investment with Finagraph and our ability to partner in product development. We wanted to point that out, and in particular, because it addresses a part of the market that some of our traditional products really aren't focused on in terms of smaller businesses.
Okay. All right. Thanks a lot, guys.
Thank you. We'll continue on to Andre Benjamin with Goldman Sachs.
Thanks. I guess I'll follow up first on the ERS business. Just to clarify, it sounds like the way we should think about the progression of revenue through the rest of the year is that the third quarter should be pretty stable relative to the first two, or you still get the seasonal pickup in the fourth quarter of the year. Or should we actually see a bit of a dip given you don't have the big contracts coming through?
No. You should expect a dip, Andre, because keep in mind, we're guiding in ERS to top line growth in the high single digits. Obviously, we're running well above that thus far this year. Recall that we had that very big pull forward in the fourth quarter of last year. Our original guidance this year, when we did our fourth quarter earnings call, our original top-line guidance for ERS was low single digits. We took that up to high single digits at the end of the first quarter after we did the GGY acquisition. Our expectations for this year were fairly modest growth in ERS relative to our historical growth rates because of that big pull forward we had at the end of last year.
Got it. I guess just to revisit the topic of international partnerships and how things are maturing and some of the more emerging opportunities in China and India and other significant long-term opportunities, is there any update on conversations around where you see additional opportunities to get more share there or how those markets are maturing for issuance? That'd be great.
Yeah, sure. With respect to India, the business that we're doing through ICRA is growing nicely. It's meeting our expectations for when we took majority control of ICRA. I think China's a different story in the sense that really not much has developed on the policy and regulatory side in recent months. We have seen defaults occurring in the Chinese market. You may recall, we've talked about this before, that how that market evolves in terms of the willingness to allow credit problems to be revealed in the market rather than protected, whether it's through the banking system or the government, is going to be important for the role of particularly credit ratings that we're offering, but also our research.
I'm not obviously rooting for any companies to default, in terms of a market structure development, I think it's promising to see that distressed companies are being allowed to fail. That's a promising development. Thank you.
Thank you. We'll go to Peter Appert with Piper Jaffray.
Thanks. Good morning. Linda, can you give us a little bit of commentary on what you're seeing and what you're expecting in terms of operating margins for the two segments? I'm noticing that the MIS margin's relatively flat year-to-year, which is pretty impressive given the revenue pressure. The Analytics margin though continued to be relatively soft. I know some of that is GGY, are there other factors you would call out?
Sure. Peter, you're correct regarding GGY, Mark will comment on this in a moment, as Mark's contribution to revenue, or Moody's Analytics contribution to revenue is now 33%, up from last year's 31%, MA finds itself in the position of attracting more overhead because of the revenue split. That is one factor that makes it a little tougher for the margin to climb in the MA business. Beyond that, I'll let Mark comment a little further on what he's seeing.
Yes, that's absolutely right, Linda. We've got two things hitting the margin. We've got the GGY acquisition. The dynamics there are that in this year, we're getting more expense than revenue, not because it's not a profitable business, but just because of the accounting treatment of the acquired revenue. We take a haircut on that this year. We've got the integration costs associated with the acquisition as well as some deal costs. It's certainly dilutive to the margin this year from the GGY acquisition. Then we've also got the point that Linda made about our attracting more corporate overhead as our share of total MCO revenue goes up. If you adjust for those two things, you'd actually see some modest margin improvement in MA.
Certainly all of the work that we're doing and the plans that we have to achieve margin expansion in MA are in place. We continue to move forward on those. We like the progress we're making. From an operational perspective, we feel very good about where we are. It's just the way the numbers move around. It's difficult to see that on the P&L in the short run.
Any change, Mark, in terms of your expectations around being able to get to mid-twenties margins and any update in terms of timeframe?
No. That's still our plan. We've got a whole operating plan around that as you know is largely an ERS project, and it's still very much the plan for the business. Peter, just to emphasize, this is also being exacerbated by the fact that MIS is in a soft period in terms of revenue growth. As MIS resumes its growth trajectory, growth pattern that we've seen historically, there will be a more favorable treatment of overhead for Moody's Analytics.
That's helpful. Thank you. Linda, can I ask you one other thing? On the stock buyback front, you've been repurchasing shares. Your cash outlay for share purchases exceeded free cash flow in recent years, the debt levels obviously have gone up. I'm wondering how you're thinking about this over the next couple of years in terms of your comfort level with continuing to move the leverage ratio up.
Sure, Peter. We're quite comfortable with the leverage level that we have right now. Obviously, maintaining our rating is very important. That's critical to us. We're being very thoughtful about this because operating cash flow based on net income is down a bit this year, we've got to be thoughtful about that. I think we will attempt to stay in the sort of range where we have been. We'll give guidance in February about the actual number for next year. I think around this neighborhood of $1 billion seems to feel pretty good for us. We'll have to look at it for next year in terms of where all the numbers come out. Maybe somewhat lighter, we're going to have to see what we have going on as we move into next year.
Great. Thank you.
Thank you. Our next question comes from Toni Kaplan with Morgan Stanley.
Hi, good morning. In the prepared remarks, you mentioned a pretty negligible impact from the move in effects from the British pound. Based on your mix of pound revenue and expenses, we would have thought, I think that there'd be a greater net benefit to EPS. Could you just give some color on maybe why that's not the case?
Toni, it's Linda. Thanks for your question, and I get all the complicated answers today. Let me try this. We did, in our 2015 investor day, talk about that only 2% of our revenues are GBP denominated and 14% of our expenses are. We did anticipate this question as to why this hasn't been more helpful to our EPS. While those numbers are correct, as you move down the P&L, the benefit is not as strong. Currently, our entity structure takes away some of that benefit, and reported revenue and expense activities in British pounds essentially offset each other, given the way we have some of our legal entities and tax structuring set up. The existing structure reflects various operational, financial, and legal considerations, and we look at those and make adjustments when appropriate.
Following the Brexit vote, we're frankly going to have to wait and see what happens to see how we best might react to that. Right now, the situation's very unclear. You're correct. There is a mismatch, but as you move down through the operating structure we presently have in place, those numbers become more evenly matched. I hope, Toni, that that's a thorough enough explanation for you.
I'll just add, as this relates to a question that was asked earlier in terms of our reaction corporately to the Brexit vote. This is one of the areas where we will be looking at whether we can improve the benefit from the mismatch between revenues and expenses coming out of the U.K. That will involve looking at our operational and legal structures and seeing what we might be able to change in terms of trying to realize the benefits from that revenue cost misalignment.
Okay, great. I think earlier in the call, in one of the answers you mentioned a bit of a pull forward in issuance. Is there any way to quantify that or just give a little bit more color on that? Thank you.
I don't know if one of my colleagues can quantify that, but we clearly saw a very active second quarter in issuance activity coming out of Europe. The corporate finance and structured finance were both up double digits in Europe in the second quarter. We are attributing a portion of that to likely pull forward. The fact that post-Brexit, we went several weeks without really seeing much of any activity in terms of European issuance just reinforces that belief that we had some pull forward. I would also take this opportunity to just highlight that if we are correct about that pull forward and correct about the slump in issuance activity being a result of Brexit as opposed to just seasonal, we would expect to see a more pronounced sawtooth pattern this year than we might have otherwise expected.
Less issuance and revenue in the third quarter, as a timing matter probably more than we had anticipated in the fourth quarter. I think it's not going to change the sawtooth. It's just going to emphasize that.
The only thing I would add to that, Ray, we saw the highest level of fundamental issuance activity in Europe since the first quarter of 2015. In addition, we had the introduction of the CSPP bond-buying program in early June, which further supported issuance there.
Yeah.
Great.
Just one last thing, Toni, as we look at this. The 10-year Treasury's been about 1.56, 1.59. Spreads for financing for investment-grade bonds might be around 144. If you are a U.S. corporate, you can issue a 10-year somewhere around 3%, which is historically very attractive. The numbers in Europe, the spread would even be tighter, maybe around 100 basis points. Issuance there is even more attractive. High-yield spreads have come in quite a bit. We're looking at about 540 basis points. The overall conditions are really quite favorable and really good. We're waiting to see what happens as we come out of this blackout period. Corporates are finding that overall rates and spreads are both very attractive. We're just going to have to wait and see what happens as we roll the calendar forward.
Traditionally, as you know, August is a weak-ish time, but it is possible that after Labor Day, we may see additional activity, and we'll see how that goes for the third quarter.
Very helpful. Just lastly, this is sort of a more broad question, but how are you thinking about the potential impacts that Brexit may have on European disintermediation? Either positive or negative.
My view at this point would be that the disintermediation is going to continue, assuming what I described earlier as a soft landing. Certainly, if there is a more fundamental disruption of the European Union or participants in the Eurozone, that would have at least cyclical and potentially more structural impacts. We do not anticipate that being the case. I think the disintermediation will continue to be a fundamental driver of the business coming out of Europe.
Thanks a lot.
Thank you. Our next question comes from Craig Huber with Huber Research Partners.
Great. Thank you. A few questions. First, Linda, just trying to better understand the costs in the quarter. Incentive compensation, I believe, is $32 million in the first quarter. What was it in the second quarter, please?
Sure. Incentive comp for the second quarter was $35.6 million, Craig. That was 10% of the total comp expense for the second quarter. Last year, that incentive comp expense was $42.8 million. We're down 17% year-over-year. As we've said many times before, the incentive comp line takes the first hit so that we can hold the margin. Frankly, we're pretty pleased about the 44.2% margin in the second quarter.
Okay. Also a currency question. What do you think about the third and fourth quarter for currency impact on your total revenues and in your costs? I'm just curious what you're budgeting there for 3Q and 4Q, please.
Sure. For the full year 2016, we're expecting that FX will have about a 1% negative impact on revenue, Craig, and about a 2% benefit on operating expense. You can sort of work with that to see what you want to do with the balance of the year.
Okay, that's helpful. Also, because I typically like to ask, can you break out the revenues within your four main categories within ratings, high yield, loans, investment grade, et cetera, the revenues there?
Craig, given that we have so many analysts these days, we have an exciting announcement for you. That is, in the interest of time, we're going to be posting your revenue breakdown that you'd like to see under Select Financial Information under that section of the IR homepage, and you can find that at ir.moodys.com. You no longer have to write this process, Craig, we hope you're pleased.
That's very helpful. One last quick question here. Ray or Linda, when you look out the next three to four years, you've talked a lot about the very strong refinancing walls here and stuff. I'm curious from a mix standpoint from a revenue, is that not helpful to your margins going forward if it's much more heavily tilted towards refinancings as opposed to a lot more new mandates where you probably have to hire a lot more analysts over time?
Yeah. All things being equal, yes. Refinancing is margin friendly. I hope that we're seeing a strong drive of new rating mandates and new business and high growth coming out of Moody's Analytics, which would constrain the margin expansion. We'll have to see. You're correct. All things being equal, that's going to help margins.
Craig, it's Linda. Just another quick thing to consider is as we move through the back half of the year, it is possible we may start seeing pull forward from 2017. You're correct that our refinancing walls, particularly in the U.S., are much more helpful to us in 2017 and on through the next few years. That's something we took a look at as we thought about our strategic plan. We would hope to have margin expansion as we move through the rest of the decade. We'll hope to have more to say about that as we move through the guidance cycle for next year. Given the pretty attractive situation we have right now with rates, it may be possible that we start to see that 2017 pull forward even at the end of this year.
One thing we would like to make very clear to everyone is that looking at the back half of the year here, our expectation is that the fourth quarter will probably be stronger than the third quarter, given the traditional slowdown during the August period. Just something to think about as you look at our normal sawtooth pattern, we think that that will persist.
Thank you.
Thank you. We continue on to Joe.
It's like you kind of made the decision to take down sort of the issuance outlook, you didn't take down the full guidance. I'm wondering, is there a discrepancy in a particular thought process behind the differences in the two?
It's really that compared to the first quarter, we're anticipating less revenue, less expense, and as a result, guiding toward the lower end of our range while still holding the margin. All of that happens to be within the ranges that we had previously communicated. There's movement within the range, but not crossing from mid-single to low single or high single to mid-single, for example.
Okay. Obviously Brexit is going to take a while, and there's an extended timeline associated with it. I just wanted to get your thoughts on any particular either upcoming Brexit milestone, I guess is what I'd call it, or event. If you think that there might be any kind of unique behavior. In other words, can we see a situation where issuance is still taking place in the U.S. and it's just contained to the U.K.? I just wanted to get some further thoughts on how you look at both of those.
At this point, I would say this process is characterized by an absence of milestones. It's very fluid, even in terms of when the Article 50 letter might be delivered. I think it's going to create, as Linda described earlier, periods of risk on and risk off. As negotiations move forward, there are elections in France and Germany and the Netherlands next year. There's a constitutional vote in Italy later this year. There are lots of things that are going to be happening that Brexit may influence, or may influence the timing of the leave decision and the notice. I agree, it's going to be a protracted process and it's one that, as I said, looks very fluid at the moment.
Joe, it's Linda. Also, to add to that, of course, we have the U.S. election in November, which potentially could cause borrowers to step away from the market for a bit of time. However, indication from the ECB seems to be that there is the potential for even further easing given what's happened with Brexit. As we thought about this, we kept our range, and we indicate the lower end of the range. I think it would be very fair to say there's an unusual amount of uncertainty around this, and it could break either way. We just don't know. If conditions continue to be very attractive and we see pull forward in the fourth quarter, this could turn out differently. We think it's prudent given all of these various factors which are causing a lot of choppiness, that we think about it in this manner.
I don't know, Brent, whether there's anything further that you wanted to say about this was a tough set of guidance for us to work through.
Okay. Just lastly, you talked about maybe some operational changes, particularly with the way that you look at the U.K. I'm wondering, as we look at this on a broader scale, is there anything that you could point out that you're doing internally any different from either a resourcing perspective, just in preparation for what could be some unusual volatility associated with, again, I guess, lack of milestones?
At this point, well, since the beginning of the year, we have had a Brexit working group. That working group was expanded after the vote and includes multiple functions and disciplines throughout the organization, operational and accounting and legal, et cetera. It's really in an intelligence-gathering phase at this point. There's not a lot that we feel we can appropriately do in terms of any changes to our activities at this point in time. We want to be prepared to make any appropriate changes depending on how this process plays out. I do want to emphasize that however it plays out, it looks like we're going to have a good long lead time to respond.
I don't think this is going to be a process that surprises us in terms of some negative consequence for the company that we don't have time to adjust to well before any decisions become effective.
Yeah, it's probably useful to add that we're conducting business as usual with a very close eye on our expense base. I think you saw that we've guided to 4% expense growth this year. It's pretty simple, actually. We're directing headcount and other resources toward the Moody's Analytics business in sort of a two-thirds, one-third split with the rating agency getting the one-third because the rating agency is having a little bit of a softer patch. In fact, for the rating agency, Q2 expenses were down 2% year-over-year. Most of the expense work that we've been doing comes on the T&E line and other things having to do with both the rating agency and the shared services organization. We are investing in the businesses that are performing well.
I think we're being very thoughtful on the rating agency, and we're being really thoughtful on the shared services part of the organization. We feel good about how we're managing all of this. We continue with the acquisitions, including GGY and the remainder of KIS. We've had these periods before, and we tend to work through them, and conditions do change from quarter to quarter.
Okay. Thank you.
Thank you. We'll now go to Bill Warmington with Wells Fargo.
Good afternoon, everyone.
Hey, Bill.
A question for you on Moody's Analytics. Just wanted to ask if you're seeing any change in the selling environment for ERS and professional services.
No. No, we're not, Bill. It's very much business as usual, to be honest. I've been in London the last couple of days and spent a lot of time with the sales team. We've got a lot going on. We're very busy. As I said earlier, the pipeline's good. So, no.
Okay. Thank you. For the new MARQ product, does that compete or will it compete with your former parent at Dun & Bradstreet? How do you see that evolving?
I guess the short answer, I think, Bill, is no. It certainly is a step that we're taking in that direction. It is clear to us that there's some need and some demand, from both small companies and from bankers, for more and better credit scores and credit analytics. We are exploring that, and as Ray said, we're doing that in collaboration with Finagraph, in which we made the investment earlier this year.
Okay. Last question for me is just to see if I can get your thoughts on what to do with that $1.5 billion of offshore cash. A high-class problem, I know.
Sure, Bill. It's Linda. In fact, 78% of our cash is offshore now, compared to 67% last year. We do look to use that cash to fund acquisitions. In fact, as we have done the acquisition of the rest of KIS, that's been funded by offshore cash, which was great. GGY is a Canadian company, partially funded by offshore cash, which is also helpful. For right now, we don't have any particular plans for that cash. We look at all alternatives all the time. If there's a different tax regime in the U.S., potentially we could make some changes there. For right now, we think that this situation is advantageous for us. We continue to look at everything, but we like global acquisitions, and it's a place where we continue to look. We are where we are for right now.
Okay. All right. Thank you very much.
Thank you. Our next question comes from Doug Arthur with Huber Research Partners.
Yeah, thanks. My question was on Pull Forward, and I think you guys have covered that pretty comprehensively, so I'll take a pass. Thanks.
Okay, thanks, Doug.
David Silver with BMO Capital Markets, please go ahead.
Thanks so much. I know it's late. You had given some color on your exposure revenues and expenses to the GBP. Can you just remind us what it is to the EUR as well?
I think the overall impact of FX, considering the GBP and the EUR, is what I had said before. This is kind of a blended view. We expect a 1% negative impact on revenue and a 2% benefit to operating expense. I believe if I've got it right, we were using rates of $1.34 to the GBP and $1.10 to the EUR. Excuse me, my colleagues are correcting me, $1.11 to the EUR in preparing these documents.
Thanks. I guess you had said 2% of your revenues last year came from GBP and 14% of expenses. Again, can you give us the similar numbers for the EUR, or I can always follow up offline?
Yeah, I don't have that in front of me. We're happy to follow up on that. I think this is obvious. Unlike the situation that we have in the U.K., we have a larger portion of revenue in EUR and a smaller portion of expense.
Okay, that makes sense. Thanks so much.
Thank you. Ashley Serrao with Credit Suisse.
Yeah, most of my questions have been asked and answered, thank you.
Okay, thank you.
Thank you. At this time, I'd like to turn the conference over to Mr. Raymond McDaniel.
Thank you very much for joining us today, thank you for the questions. We look forward to speaking to you again next at our Investor Day on Wednesday, September 28th. Thanks all, and we'll see you then.
Thank you, ladies and gentlemen. This concludes Moody's second quarter 2016 earnings call. As a reminder, a replay of this call will be available after 3:30 P.M. Eastern Time on Moody's IR website. Thank you. You may now disconnect.