Good day, welcome, ladies and gentlemen, to the Moody's Corporation third quarter 2014 earnings conference call. At this time, I would like to inform you that this conference is being recorded and that all participants are in 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. Please go ahead, ma'am.
Thank you. Good morning, everyone, thanks for joining us on this teleconference to discuss Moody's third quarter results for 2014, as well as our outlook for full year 2014. I am Salli Schwartz, Global Head of Investor Relations. Moody's released its results for the third quarter of 2014 this morning. The earnings press release and a presentation to accompany this teleconference are both available on our website at ir.moodys.com. Raymond McDaniel, President and Chief Executive Officer of Moody's Corporation, will lead this morning's conference call. Also making prepared remarks on the call this morning is Linda Huber, Chief Financial Officer of Moody's Corporation. 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, 2013, 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, thank you, everyone, for joining today's call. I'll begin by summarizing Moody's third quarter 2014 results. Linda will follow with additional financial detail and operating highlights. I will then conclude with a few general updates and comments on our outlook for 2014. After our prepared remarks, we'll be happy to respond to your questions. Moody's achieved strong growth in the third quarter, with total revenue of $816 million, an increase of 16% over the third quarter of 2013. Record revenue growth in Moody's Analytics and double-digit revenue growth in nearly every line of business contributed to our overall performance. Operating expenses for the third quarter were $466 million, a 13% increase from the third quarter of 2013. Operating income for the third quarter was $350 million, a 20% increase from the prior year period.
Adjusted operating income, defined as operating income less depreciation and amortization, was $373 million, up 18% from the same period last year. Operating margin for the third quarter of 42.9% was up from 41.3% in the third quarter of 2013. Adjusted operating margin of 45.7% for the quarter was up from 44.6% for the same period last year. Diluted earnings per share of $1 for the quarter increased 20% from $0.83 in the third quarter of 2013. Non-GAAP EPS of $0.97, which excluded a $0.03 benefit from the resolution of a legacy tax matter, increased 17% from the third quarter of 2013. Turning to year-to-date performance, revenue for the first nine months of 2014 was $2.5 billion, a 12% increase from the first nine months of 2013. Revenue at Moody's Investors Service was $1.7 billion, an increase of 10% from a year ago.
Moody's Analytics revenue for the first nine months of 2014 of $766 million was 17% higher than the prior year period. Operating expenses for the first nine months of 2014 were $1.4 billion, up 7% from the first nine months of 2013, which included a first-quarter litigation settlement charge. Operating income of $1.1 billion increased 19% from $923 million in 2013. Adjusted operating income was $1.2 billion, a 17% increase from the prior year period. Operating margin for the first nine months of 2014 of 44.5% was up from 42.1% from the same period last year. Adjusted operating margin of 47.3% was up from 45.3%. Diluted earnings per share of $3.48 for the first nine months of 2014 increased 31% from $2.66 for the same period in 2013. Non-GAAP EPS of $3.09 for the first nine months of 2014 grew 10% from $2.80 for the same period in 2013.
Year-to-date 2014 non-GAAP EPS excludes a $0.36 gain resulting from Moody's acquisition of a controlling interest in ICRA Limited in the second quarter and the $0.03 legacy tax benefit in the third quarter. Year-to-date 2013 non-GAAP EPS excludes the first quarter litigation settlement charge of $0.14. I will 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 quarter increased 16% to $816 million. The impact of foreign currency translation on revenue was negligible for the quarter. Third quarter U.S. revenue increased 15% to $449 million, while revenue outside the U.S. grew 17% to $367 million and represented 45% of Moody's total revenue for the quarter.
Global recurring revenue grew 10% to $415 million and represented 51% of total revenue, down from 53% in the prior year period. Looking now at each of our businesses, starting with Moody's Investors Service, total MIS revenue for the quarter was $543 million, up 14% from the prior year period. U.S. MIS revenue of $329 million increased 13% from the third quarter of 2013. MIS revenue generated outside the U.S. of $214 million increased 14% and represented 39% 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 in the third quarter increased 12% from the year ago period to $261 million. Despite a year-over-year decline in global non-finance corporate bond issuance volume and flat-rated bank loan issuance volume, Moody's benefited from a greater number of smaller deals.
This favorable mix of bond and bank loan issuance, as well as additional monitoring revenue associated with new ratings customers, were the primary drivers of year-on-year revenue growth in the corporate finance line of business. U.S. and non-U.S. corporate finance revenue were up 8% and 19% respectively. Second, global structured finance revenue for the third quarter was $102 million, an increase of 22% from the prior year, primarily reflecting increased rating activity for U.S. collateralized loan obligations, or CLOs. U.S. and non-U.S. revenue increased 31% and 7%, respectively, against the prior year period. Third, global financial institutions revenue of $92 million increased 16% from the same quarter of 2013. U.S. revenue increased 9%, primarily due to increased issuance by insurance companies. Non-U.S. revenue increased 22% due to higher levels of bank issuance from China and Europe.
Fourth, global public project and infrastructure finance revenue increased 7% year-over-year to $89 million. U.S. revenue increased 15%, primarily due to increased rating activity in public finance and project finance. Non-U.S. revenue decreased 5% from the prior year period, primarily due to lower infrastructure issuance in Europe. Turning now to Moody's Analytics. Global revenue for Moody's Analytics of $273 million was up 20% from the third quarter of 2013. Foreign currency translation favorably impacted MA revenue by 2%. U.S. revenue grew by 19% year-over-year to $120 million. Non-U.S. revenue of $153 million increased 21% from the prior year period and represented 56% of total Moody's Analytics revenue. More than two-thirds of MA's revenue growth in the quarter was organic, with the remainder coming from acquisitions. Moving to the lines of business for MA.
First, global research data and analytics, or RD&A, revenue of $147 million increased 10% from the prior year period, driven by strong sales of credit research and content licensing. RD&A's customer retention rate remains strong in the mid-90s percentage range. RD&A U.S. and non-U.S. revenue were up 6% and 14%, respectively, as compared to the third quarter of 2013. RD&A represented 54% of total MA revenue. Second, global enterprise risk solutions, or ERS, revenue of $81 million grew 26% against the prior year period due to growth in revenue from subscriptions and services. U.S. and non-U.S. revenue were up 23% and 27%, respectively, against the same period last year. Excluding WebEquity, which we acquired in mid-July, ERS revenue increased 21% from the prior year period. Trailing 12-month revenue and sales for ERS increased 14% and 15%, respectively.
As we've noted in the past, due to the variable nature of project timing and completion, ERS revenue remains subject to quarterly volatility. Finally, global professional services revenue grew 54% to $45 million, primarily reflecting the December 2013 acquisition of Amba Investment Services. U.S. and non-U.S. revenue increased 130% and 28%, respectively, year-over-year. Turning now to expenses. Moody's third quarter expenses increased 13% to $466 million compared to the third quarter of 2013. The increase was primarily due to higher compensation and real estate costs attributable to additional headcount, as well as increased incentive compensation accruals. The impact of foreign currency translation on operating expenses was negligible. Moody's reported operating margin for the quarter was 42.9%, up 160 basis points from 41.3% in the third quarter of 2013. Adjusted operating margin was 45.7% for the quarter, up 110 basis points from 44.6% for the same period last year.
Moody's effective tax rate for the quarter was 33.5%, an increase from 29.1% for the prior year period, primarily due to higher U.S. and non-U.S. taxes on foreign income, as well as certain discrete items that reduced the effective tax rate in 2013. Now I'll provide an update on capital allocation. During the third quarter of 2014, Moody's repurchased 3.5 million shares at a total cost of $320.5 million, or an average of $91.89 per share, and issued 900,000 shares under our employee stock-based compensation plan. Outstanding shares as of September 30th, 2014, were 208.6 million, reflecting a 3% decline from a year earlier. As of September 30th, 2014, Moody's had $1 billion of share repurchase authority remaining under its current program. At quarter end, Moody's had $2.5 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 $2.1 billion, an increase of $61 million from a year earlier. As of September 30th, 2014, approximately 66% of our cash holdings were maintained outside the U.S. Free cash flow for the first nine months of 2014 of $653 million, increased $30.5 million or 5% from the same period a year ago. With that, I'll turn the call back over to Ray.
Thanks, Linda. First, I'd like to provide a brief recap of the regulatory update that we provided at Investor Day. In the U.S., in August, the SEC voted to adopt its final rules for NRSROs as required by the Financial Reform Act. The final rules closely track the proposed rules, which had been published in 2011. In anticipation of the final rules, Moody's has made substantial technology and other investments over the past several years. Consequently, we will be in a position to implement the relevant compliance obligations by the SEC's deadlines. Turning to Europe, certain of the provisions of CRA III are subject to further rulemaking. The next round is expected to conclude by the first quarter of 2015, and will include certain reporting requirements and disclosure obligations.
On a separate note, for the third year in a row, Moody's Investors Service was voted the best credit rating agency in a 2014 poll of U.S. fixed income investors conducted by the well-known publisher, Institutional Investor. MIS was also again named Asia's most influential credit rating agency in a similar poll conducted by the publisher FinanceAsia. Moody's Analytics was named the best regulatory capital calculation management provider and the best asset and liability management provider by Asia Risk Technology Rankings. I appreciate the market's recognition of our efforts, and I applaud the accomplishments of both the MIS and MA businesses. Finally, I'd like to discuss the changes to our full year guidance for 2014. The full list of Moody's guidance is included in our third quarter 2014 earnings press release, which can be found on the Moody's investor relations website at ir.moodys.com.
Moody's outlook for 2014 is based on assumptions about many macroeconomic and capital market factors, including interest rates, corporate profitability, business investment spending, merger and acquisition activity, consumer borrowing and securitization, and the amount of debt issued. There's an important degree of uncertainty surrounding these assumptions, and if actual conditions differ, Moody's results for the year may differ materially from the current outlook. Our guidance assumes foreign currency translation at end of quarter exchange rates. Based on our strong year-to-date performance, we are reaffirming our non-GAAP EPS guidance in the range of $3.95-$4.05. This range excludes the $0.36 gain resulting from Moody's acquisition of a controlling interest in ICRA Limited in the second quarter, and the $0.03 legacy tax benefit in the third quarter.
Additionally, while global MIS revenue for the full year 2014 is still expected to increase in the high single-digit % range, non-U.S. MIS revenue is now expected to increase approximately 10%. Within MIS, Corporate Finance is now expected to increase approximately 10%. Structured Finance is now expected to increase in the high single-digit % range. And lastly, Public Project and Infrastructure Finance is now expected to grow in the mid-single digit % range. This concludes our prepared remarks, and joining us for the question and answer session are Michel Madelain, President and Chief Operating Officer of Moody's Investors Service, and Mark Almeida, President of Moody's Analytics. We'd be pleased to take any questions you may have.
If you would like to ask a question, please signal by pressing star one on your telephone keypad. If you're using a speakerphone, please make sure your mute function is turned off to allow your signal to reach our equipment. Again, that's star one to ask a question via the phones at this time. And we'll take our first question from Alex Kramm with UBS.
Oh, hey. Good morning, or hello everyone, actually. Wanted to just talk about the current business and what you're seeing out there. Clearly with all the volatility in markets, issuance has slowed down a little bit in October. Maybe you can talk a little bit more about what you're seeing out there when you talk to desks, and obviously how that has impacted your guidance. You obviously lowered a couple items. Are you feeling still very confident in making that guidance this year, or does the current outlook concern you a little bit more here? Thanks.
Alex, it's Linda. Let me talk a little bit about what we're hearing from various desks, and then I'll let Ray comment on his thoughts about that. For investment grade, we've had a very good settling of the market since last week. Last week did see in the U.S. reduced investment-grade issuance with only $6 billion. This week, and I just checked before I came upstairs, it's probably going to be a $20 billion week, a little bit better. Next week looks to be the same or a little bit better. What we're seeing though is that pipelines are robust. The pipelines are quite strong. We're expecting a heavy fourth quarter in investment grade because we have $100 billion of M&A pipeline that needs to be financed before the end of the first quarter in 2015. Investment grade looks like it's stabilized and looks quite strong.
High yield did take a step back last week and had only one deal priced last week. This week it's been quite a good bit healthier though. I think we'd characterize the state of the high yield market as improving, and we have seen some transactions that are looking ready to come next week, that's good. The pipeline would be viewed as average, however. On leverage loans, we also see an average pipeline, and we do see perhaps $20 billion in leverage loans for October. Again, that pipeline's looking a little bit on the average side as well. Very good strength in investment grade, a lot of backlog there, and high yield and leverage loans looking more on the average side. With that, I'll let Ray translate that for you.
First of all, I think we do feel pretty confident with our outlook for a full year. Certainly, we are cognizant of the volatility that we've seen in the market recently. Not surprising. We've been dealing with this for quite a while. There are periods where the market, the pipeline slows. It's really not a question of the pipeline as much as it is whether that pipeline is pushing forward. As Linda described, we see particular strength in investment grade, and more average pipelines in the spec-grade bond and loan areas. Really just underscoring Linda's comments.
Okay, great. Maybe just as my follow-up here, maybe a little bit more detail, but on the recurring revenue in MIS, that's obviously been a nice stable driver. I think, Linda, you mentioned it in your prepared remarks this quarter, I think 10% year-over-year growth. More interesting though, what I noted is that quarter-over-quarter, down from the second quarter, recurring revenues actually declined a few million, I think, in corporate and structured. I think this was the first time we saw that in several years. I usually think about recurring revenues as kind of building on top of each other. Maybe was there anything particular that was going on this quarter or why would that be coming down? Thank you.
Sequentially, Alex, you're batting 500, if I can say that. On CFG in the second quarter, we had $82.4 million of relationship revenue, and it was down to $80.7 million in the third quarter. In structured, however, we had $40.6 million, and we're up to $41.5 million. I wouldn't take too much away from that quarter-over-quarter, and I'd ask Michel to comment if he thinks there's anything of particular note in that. We do have new rating mandates coming online, and as we said, as those come into our stock of monitored ratings, they do add to that recurring revenue total. I don't think there's anything particularly unusual going on quarter-over-quarter. Michel, anything you'd like to add?
No. I was going to say the same thing. Really nothing to point to any sort of structural change. Positive momentum from additions to the portfolio continue. No, nothing to add. There may be a forex element here. You may want to comment on that, Linda.
The foreign exchange element was not material, so that really wasn't a driver. The trend, we believe, is going to continue to see increases in the recurring revenue. It really follows on from the new rating mandates that we're getting and that turns into monitoring fees in the forward years. We do expect the upward trend to continue.
Okay, fair enough. Just stuck out a little bit to me, but I appreciate it. Thank you.
We'll move to our next question from Manav Patnaik from Barclays.
Hey, good morning, afternoon, I guess. The first question I had was, I guess the two things that the post change from the MIS today was just the slightly more negative European outlook, recently, I guess we had those risk retention rules signed on the structured side. I was just wondering if you guys had a view on those risk retention rules and how that might impact the structured business, especially in the U.S.
We obviously have been watching the risk retention rules and the fact that the various regulatory authorities approved those rules earlier in the week has caused quite a bit of commentary in the market and anticipation of what this may mean. Certainly in the near term, we don't see any significant impact. There are periods of 1-2 years before the risk retention rules become effective after they are published. In the longer run, we would anticipate that there will be at least some modest impacts. The way the risk retention rules have been developed are going to affect different asset classes differently. For example, we might anticipate some of the smaller CLO arrangers and issuers to be less active, while the larger ones that have more capacity to deal with the risk retention would probably remain active.
The only other comment I'd make on this, because really, I think there is a lot of uncertainty about exactly how the market is going to deal with these risk retention rules and how the market's reaction will evolve. To the extent that it decreases activity in certain parts of structured finance, I would anticipate that's going to increase activity in other parts of the market. There's going to be an offset. For example, if there is some reduction in CLO activity, we may see an increase in high-yield bond activity. We'll have to watch and see, but we've got a fair amount of time before these rules become effective. As far as the European outlook, let me ask Michel if he would comment on that.
Thank you, Ray. Well, in Europe, I think we do see, effectively, a macroeconomic situation which is obviously not very favorable, and that has an impact on some of the activities we see. As you may have seen from our guidance and our numbers, some of the adjustments were made in Europe, in CFG, and structured finance. There is clearly a slower pace, and that's something we've seen last quarter and we anticipate to see in the next quarter.
Okay, thanks.
Thank you.
Just one more on ERS. I guess how much of the improvement on the top and bottom line, I suppose, was due to timing versus an actual acceleration in the underlying trends?
Yeah. Mark, you want to?
Sure. Well, the top line was very much a function of timing. A lot of the revenue we recorded in the quarter was the result of our completing projects and recognizing the associated revenue. That was certainly an element of what was going on. It was a very strong quarter across the board, across all of our product lines and our various delivery mechanisms in ERS. We haven't disclosed anything on the ERS bottom line, I'm not sure that I have much I can offer you on that.
All right. Thanks, guys.
We'll move to our next question from Bill Bird with FBR.
Yeah, good morning. Also on MA, I'm sorry if I missed it, but what was the segment's organic growth, and was there anything unusual driving the higher profit pull-through on revenue growth in MA in the quarter? Thank you.
Well, the organic growth was about two-thirds of total growth. We reported we were up 20. About two-thirds of that is organic. The organic number was very strong. The improvement in the margin, I think, is largely attributable to the contribution from the Copal Amba business. I don't think that reflects all that much, frankly, about the longer-term efforts that we're making in Moody's Analytics and in ERS specifically to drive margin. That's going to be a longer-term effort that will play out over a period of years.
I would just add in terms of the organic growth that we had double-digit organic growth in each line of business within Moody's Analytics. It was very strong performance across the board.
Separately, just to follow on Europe, would just be curious of your perspective on the new ABS and covered bond purchasing program and how you see that impact in the European structured business.
Yeah, I'll offer a comment, and if Michel wishes to add anything, I'll invite him to do so. Really, we don't see it having a large impact on the market. I think it would have a more significant impact if the issues were around liquidity and the availability of liquidity. That has not really been the principal issue. I think it's more of a supply-demand issue. While it's probably going to be helpful at the margin, I don't think it really gets to the heart of what's causing the European structured market, covered bond market to be soft. Michel, if you have anything to amplify my comments, please do.
No, not really.
Okay. Thank you very much.
Thank you.
We'll take our next question from Joseph Foresi with Janney Montgomery Scott.
Hi. First, sort of a big picture question. We've seen, I guess, interest rates move down a little bit over the last couple of months. How should we think about the relationship? I know what part of this answer is going to be, but how should we think about the relationship between interest rates and sort of what you're thinking about for growth rate for next year? In other words, if they tick down, should we be more encouraged for a growth rate or less? And how should we think about that?
Yeah. We've talked about this some before, my views at least have not fundamentally changed. Certainly, interest rates being as low as they are encourages more opportunistic financing, pre-financing, and it's also encouraging I think the speculative grade market because of the reach for yield. Lower quality credits that are offering higher yields are attractive. I think we'd actually benefit from seeing some more economic growth globally in terms of Europe, also some concerns about Asia. I think is going to have an impact on whether we're going to get these other elements of issuance to be more active.
Joe, it's Linda. Just a couple of quick follow-ons. As we started the call this morning, the 10-year in the U.S. is about 2.25. The blue chip forecast for next year, the median scenario, is about 3.25. There's also a strong view that perhaps the lower end of that forecast that has the 10-year at about 2.8 might actually prevail. This sort of range is a bit of a sweet spot for us. As we said, we see very strong investment-grade pipelines, and we just need a little bit of calm in order to have better conditions in the high yield and leverage loan markets. U.S. Treasuries still are a much higher yielding security than European bonds at this point.
We think that demand for U.S. Treasuries is going to, in the immediate term, keep interest rates relatively close to where they are. We think that presents quite a reasonable outlook for us. You're right, it does appear that rates may be lower for longer than had been feared earlier this year.
Got it. Just to summarize so I'm clear. Ultimately, the drop in rates is an incremental positive. If the macro remains steady, we should think about that as incrementally positive outlook for next year. Is that fair?
Well, this is somewhat speculative.
Okay.
I would say probably the best condition for us would be a modest increase in rates if that is the result of more confidence in the business environment. The rates where they are now, to the extent they are reacting to geopolitical conditions and weakness in Europe, certainly provide attractive financing rates. Absolute rates, it's difficult to envision a scenario where absolute rates are not pretty attractive in 2015 anyway. I wouldn't mind seeing the rates move up a little bit with more business confidence.
Got it. Okay. Just last one from me. Obviously, we talked about the organic growth rate in the Analytics business. When we look at that aggregate rate going out past the next couple of quarters, is there a step-up in the organic once you include those acquisitions going forward? How should we think about the long-term rate in that business or growth rate in that business?
Well, I think that we would expect our organic growth rates, all things being equal, to remain around where they are today. Now, of course, there's a lot that can happen that will influence that, particularly when it comes to the movements in currencies and things like that. As I said, all things equal, we would expect to be able to sustain our current level of organic growth.
Thank you.
We'll move to our next question from Craig Huber with Huber Research Partners.
Yes. Hi, thank you. My first question, Linda, just a general housekeeping question. Can you help us break out your four ratings areas, the revenues finer, like within corporate finance, high yield bank loans, investment grade, et cetera, in the quarter?
Sure, Craig. Starting first with corporate finance. Investment grade for the quarter is $39 million, which is 15% of the total line of $260.7 million for corporate. Spec grade is at 54 and a half, or 21%. Bank loans, $62 million, 24% of the total line. Other accounts at $105 million. The big news there would be the strong growth in the investment grade line and also strong growth in the spec grade line. It may be puzzling. We've heard a lot of questions from analysts this morning as to how can it be that those two lines have been down in terms of what they're looking at in terms of issuance activity, and yet revenue is up. We would comment our usual caveat that it's very hard to track our revenues from issuance, and trying to do it is obviously a challenge.
On the investment grade side, the difference would be that last year we had the Verizon deal, which was $49 billion in the third quarter numbers. If you take that out, U.S. investment grade issuance is actually up 17% in the U.S. Mix is important to us. More smaller deals are better for us. In high yield, the situation is about the same. We saw fewer jumbo deals than last year, and particularly in EMEA, we saw better revenue yield because of smaller deals, which are helpful to us. Again, just looking at the headline issuance numbers are not going to help you. You have to look at the deal size and what was going on in the previous year. With those comments, I'll move on to structured finance. Total was $102 million for the quarter.
Asset-backed, we saw $23 million, that's about 23% of the total. RMBS, $18.3 million, 18% of the total. Commercial real estate, 26.9 or 26% of the total. Structured credit, 33.8 or 33% of the total. Here are the big drivers in structured credit, which has moved up to $33.8 million from $20.1 last year. That's all about the growth in CLOs. That sector has been very strong for us in structured. Seeing global structured up 22% is a nice change, and we're very pleased about that. Moving on to financial institutions. Total for that line is $91.8 million. Banking is $60.7 million of that or 66%. Insurance, $27.1 million or 30%. Managed Investments $4 million, about 4%. There we saw good growth both in the banking and the insurance line as we had commented previously.
Public project and infrastructure, a total of $88.5 million. $40 million from public finance and sovereigns, 45% of the total. Munis, about $4 million or 4% of the total. On project and infrastructure, about $44.8 million, 51% of the total. There, in PFG and Sovereigns, we saw good growth year over year. That's the story on the rating agency, Craig.
I appreciate that. Then also, can you just give us, if you would, please, the incentive comp number in the quarter?
Sure. Hang on just a second. Incentive compensation for this quarter was $46.8 million. We did increase that a bit from last quarter's $44.2 million. That came with the change in guidance. You saw that we had pretty good performance. For the fourth quarter, I would suggest that you model somewhere between $40 million-$45 million. It depends how we do. That number's going to move around depending on how we do for the end of the year.
Okay. Then also, if I could ask Ray or yourself, what do you think needs to change in the marketplace right now to kind of see RMBS pick up significantly from here in the U.S.?
Yeah. Right now it looks as though it's policy driven as much as anything having to do with market conditions or market forces. The role of private label mortgage-backed securities remains very small. Probably the most expedient way to grow that market would be if there were lower limits on qualifying mortgages that would go into Fannie and Freddie. I'm not aware of any moves to make that happen. It looks like the U.S. RMBS market, at least, is going to remain relatively soft. In Europe, again, the securitization market in Europe has been broadly soft for some time now. Policymakers would like to see more activity. They are certainly talking up a resumption of that market. To the extent that their tools are dealing more with liquidity than they are with supply-demand, they're probably only going to have limited impact.
We're waiting for change in market sentiment in Europe as opposed to the U.S.
One last housekeeping question, Linda. The tax rate as you think out to next year, are you thinking it should be similar to the 33% you're talking about for this year, or more like the mid-31s, 31 and a half or so that you had the last couple of years?
Craig, it's a little bit too soon to start talking about the tax rate for next year. We would note, though, that the tax rate for this quarter moved up quite a bit. We had been at about 29 and a half% for last year, and we're up to 33% for this quarter, which had to do with some discrete items and so on. We are expecting a little bit of this continuing in the fourth quarter. For next year, we're going to have to wait and see what everything looks like next year. We've got to kind of reset on where we're generating our income and what that means. I'm not going to venture as far as next year.
Yeah. To the extent that we're seeing stronger economic conditions in the U.S. than we are in our international business, it's going to be tougher to get a low tax rate. Just a small cautionary note there.
Okay. Thank you.
We'll move to our next question from Timothy McHugh with William Blair & Company.
Yes, thanks. Just wanted to ask on the financial institutions group, the strength you saw there. I understood where it was coming from. Is there an anecdotal explanation for why you saw that strength? Something particular happening amongst that client group?
Well, it was largely European and Asian financial institutions that are not frequent issuers accessing the markets. They're taking advantage of market conditions. Since they are not frequent issuers, more of those institutions would fit into our per-issuer pricing program than the frequent issuers. We see more of an uptick when those per-issue institutions are active. That's what we saw in part in the third quarter. I'd also just point out, we saw strength in the U.S. insurance sector. That related in part to M&A activity and funding for that.
Okay. Also, somewhere related, you mentioned the U.S., more small deals are better than big deals. I guess in a rough sense, what's the range as you think about the fees you might get from a typical dollar of issuance between larger transactions versus more small transactions making up that mix?
Tim, we don't like to go too much into pricing. I think we would say the five-ish basis points we get on investment-grade deals, that serves us very well and we think provides good value for the issuers as well. On larger deals, particularly deals as large as Verizon, we wouldn't apply that same basis point level to a deal of that size. I wouldn't make an overall judgment there on what the price yield would be on those. Five-ish basis points on per issue pricing would be about right.
Okay. I guess lastly, it seems like you expect a decent-size expense ramp in the fourth quarter. I know it's always seasonally higher, but is there anything in particular going on in terms of investment spending in Q4?
Right. I was hoping someone would ask that so we could clarify this. We do still expect expenses to ramp $80 million-$90 million from the first quarter to the fourth quarter. In the first quarter, we were mentioning we had $434 million. I also was looking last year, in 2013, expenses also ramped up 13% fourth quarter versus the third quarter. The primary issue here, which I don't think everybody has thought about, is going into fourth quarter, we're picking up the operating expenses for ICRA, which is majority ownership of the Indian rating entity, and WebEquity, which we acquired in July. The two of those together and again, this is the first full quarter when we'll have those. That's $20 million that we're adding to expenses just right there. Consulting and IT will probably add a little bit shy of $20 million.
If we come in according to where we think we will with our guidance, incentive compensation will be about $10 million. Typically, the T&E bill's a little bit higher as we get into the fourth quarter as everybody is trying to get the final implementations, particularly in the M&A business, completed. I think that explains the majority of it, but the analysts may not be thinking about the fact that we're picking up the ICRA expenses and the WebEquity expenses. You're right, we do have a seasonal ramp in the fourth quarter. We may do a bit better than that, but we don't want to promise that because we're not really sure, and you've got to think about the incentive compensation piece of that as well.
Just relative to the added expense from ICRA and WebEquity, what's the right idea, I guess, for the revenue being added in from ICRA? You gave the WebEquity for a partial quarter this quarter, I guess.
Yeah. In terms of ICRA, I don't think we want to get to a specific number because ICRA is a public company in India, and we don't want to be front-running any communications that ICRA has to be making. Out of an abundance of caution, we're not going to disclose a fourth quarter expectation.
Is the right way still you're accounting for that with a lag of a quarter, though, correct?
Yes. We still have that quarterly lag, yes.
Okay. Thank you.
We'll take our next question from Peter Appert with Piper Jaffray.
Thanks. Ray, do you sense that you guys are gaining perhaps a little bit of market share this year? Are there any asset classes you would call out where you think you might be gaining some share?
We've had pretty comprehensive coverage in the market. As you know, Peter, structured finance is always a source of variability in coverage. It so happens that areas where we are particularly strong have been active in structured finance. Yes, I would say that our relative coverage has probably improved compared to competitors. We have been active in rating CLOs and CMBS. We'll do our best to make sure that we maintain both high coverage and high quality in the ratings.
Okay. Linda, FX presumably is going to be much more of a headwind in the fourth quarter. How should we think about that?
Hard to think about FX going forward, Peter. We were concerned about it, and then the dollar/euro sort of returned to where it had been. It's a little tough to tell how that's all going to pan out, but I don't think it's going to be a huge piece of input for us. One note, Peter, on the expense line that we heard some questions on earlier this morning. The interest expense, which you can see in the tables accompanying the earnings release, was $39 million in the third quarter. The reason for that was $11 million of costs as we paid our 2015 private placement a year early. We had some costs associated with that. I just wanted to call that out so that the analysts and the investors can see it.
Just one other comment on FX, Peter. A substantial part of our international billings are in euros, and a substantial part of our international expense is in pounds where we have our largest operation outside the U.S. To the extent that euros and pounds are moving in the same direction, we have a bit of a natural hedge there. If they do not move in the same direction, that's where FX could become more material to our results.
Got it. Thank you.
We'll move to our next question from Phil Wormington with Wells Fargo.
Good afternoon, everyone.
Hi, Phil.
Linda, just to continue on the interest expense question, if you back out the $11 million, it's about $28 million in interest expense. Is that a good rate to use going forward for Q4?
Yeah, I think that's probably pretty good, Phil. We did do the financing in July, so you have to consider that we've increased the run rate on that to include that financing, even though that was done at very attractive rates. It does add a bit of interest expense for it.
Yeah. 30-year money, very attractive.
It's a private quarter.
I'm seeing the headline here, "25 Eurozone Banks Said to Fail Stress Tests." My question is, with that, are you seeing an acceleration in demand for stress testing in the U.S. and Europe?
I think the short answer is yes, absolutely. I think we would also be cautious in saying that the stress tests that are being conducted are a principal driver of demand for our risk management services and our stress testing capabilities in particular. They play a role, there's a broader increase in the attention to risk measurement and risk management that's going on beyond just these point-in-time stress tests. Mark, I don't know if there's anything you want to add to that.
I think that's right. I think the specific results of the stress test aren't all that meaningful for us. It's really the existence of the stress test and the way that stress testing is being integrated into regulatory supervision of banks in the U.S., and now we're seeing it in Europe, is a good driver of demand for the kinds of things that we offer to banks.
Got it. Okay. Thank you very much.
Thanks. We'll move to our next question from Vincent Hung with Autonomous Research.
Hi, good afternoon. Maybe I missed this, but could you provide any color on the ERS project pipeline?
It remains good. We're hard at work on a lot of projects with a lot of customers around the world. I think it's very consistent with what we've been talking about and what we talked about at Investor Day. We continue to think that ERS will be the fastest-growing business in Moody's Analytics.
Okay. Is there any commentary on how the regulatory and compliance costs have trended this quarter?
No. As we've communicated previously, we think the incremental cost this year will be less than $5 million, maybe up to $5 million. As you can tell, the incremental component for the quarter would not be substantial.
Okay, great. Lastly, it's just more of a longer-term question around high-yield issuance. If I look at your revenues, they've grown in tandem with the mix shift in total debt issuance, so more high-yield issuance. It keeps getting harder to argue that mix will continue to increase towards greater high-yield issuance because we're currently running at about 8% high-yield issuance to total debt issuance for the year to date. Pre-crisis it was 3%. Clearly, some of that is going to be supported by the positive backdrop of low rates and disintermediation. How should we think about how that trend's going forward?
Yeah, there are both cyclical and structural features to the growth in the high-yield market. When we talk about high yield broadly, I would include both leveraged loans and high-yield bonds. Cyclically, yes, low rates have caused a lot of opportunistic financing. That's already been largely accomplished. The good news is that once institutions are in the market with financings, that increases the volume that will be refinanced in the future. That's a very good news story. Structurally, the conditions and changes that are going on in the financial institution sector globally, in terms of capital adequacy and stress testing and risk management and curtailment of certain business activities that are creating profit pressures, all of that is encouraging disintermediation, and a lot of that is for non-investment grade parts of the market.
Those are the institutions that historically would have been either largely or exclusively in banking relationships rather than in the bond markets, and they're going to the bond markets now. Certainly in the U.S., but also a big opportunity in Europe.
Vincent, we would also note and call your attention to what we had said earlier. This $100 billion backlog in M&A takeout financing, much of that is high yield. M&A activity generally tends toward being high yield activity. That's quite good for us. We have, again, very nice conditions here with the equity markets at highs and financing costs relatively low. We were just looking at M&A activity. It's very much at a high point right now, which is very helpful to us. The other thing I would add is that this forecast, this guidance, does incorporate the view, though, that activity in Europe is still weak-ish, not very strong. That would be the place, as Michel Madelain had commented on earlier, where we do see a little bit more concern about what's happening there. We do see good activity here in the U.S.
We're trying to put those two things together in considering our guidance. The one other thing I'd remind everyone regarding our guidance, the acquisitions we've done this year, ICRA and WebEquity together on a GAAP basis are $0.05 dilutive to the GAAP earnings outlook for this year. Just something for everyone to keep in the back of their minds. I think there's some question as to why we didn't do something more with guidance today. We would note it's only been 24 business days since we had our Investor Day. Just trying to keep everything in balance here.
Okay. Thank you.
We'll take our next question from Patrick O'Shaughnessy with Raymond James.
Hey, guys. We continue to hear complaints in the corporate bond market about the lack of secondary market liquidity. So far, it does not seem like that has impacted the ability of companies to go to the market and issue debt. Could you foresee a scenario in the future, though, where that lack of secondary market liquidity does become an issue? To the extent that it does, what sort of role can Moody's play in maybe helping that liquidity better develop?
Patrick, I don't think that it causes any hesitation in companies coming to the market. What is interesting, for companies that have well-aged bond deals and then bring new debt to the market, sometimes those new deals can trade tighter than the old deals because there's more of these newer securities than in inventory. That's a curious fact, but one that is happening quite a bit. The other thing we would notice is last Wednesday, when the ten-year traded down to 1.87, there was a view that a lot of that unusual decline was because capital markets desks at various firms are not holding the same sorts of bond inventories that they did before to act as a shock absorber as rates move around. That would be another factor that we would call attention to.
We don't think, though, that that has any impact on issuance at this point. Issuance, even as recently as yesterday, Verizon brought a $6 billion deal yesterday, and it went very nicely. I don't think we see any impact on issuance. I'd invite Ray and perhaps Michel to comment.
No, nothing to add to that, Linda. That was very complete. I don't know. Michel, if you have anything you'd like to add, please do.
No, nothing. I'm going to sign off.
All right, great. That's all for me. Thank you.
Thanks, Patrick.
There are no further questions in the queue at this time.
Okay. Just want to thank everyone for joining us on the call today, and we look forward to speaking with you again in the new year. Thank you.
This concludes Moody's third quarter 2014 earnings call. As a reminder, a replay of this call will be available after 4 P.M. Eastern Time on Moody's website. Thank you.