Good day, and welcome, ladies and gentlemen, to the Moody's Corporation second 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 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. Please go ahead, ma'am.
Thank you. Good morning, everyone, and thanks for joining us on this teleconference to discuss Moody's second quarter results for 2014 and our outlook for full year 2014. I am Salli Schwartz, Global Head of Investor Relations. Moody's released its results for the second 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 press 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.
Thank you, Salli. Good morning, and thank you, everyone, for joining today's call. I'll begin by summarizing Moody's second quarter 2014 results. Linda will follow with additional financial detail and operating highlights. We have no legal or regulatory updates to report, therefore, I will conclude our comments with our outlook for 2014. After our prepared remarks, we'll be happy to respond to your questions. Second quarter revenue of $874 million increased 16% over the second quarter of 2013. Both Moody's Investors Service and Moody's Analytics delivered mid-teens % revenue growth. Operating expenses for the second quarter were $462 million, a 14% increase from the second quarter of 2013. Operating income for the second quarter was $412 million, a 17% increase from the prior year period. Adjusted operating income, defined as operating income less depreciation and amortization, was $434 million, up 16% from the same period last year.
Diluted earnings per share of $1.48 for the second quarter increased 48% from $1 in the second quarter of 2013, and included a $103 million non-cash pre-tax gain resulting from Moody's acquisition of a controlling interest in ICRA Limited, a leading Indian credit rating agency. On June 26, 2014, Moody's increased its stake in ICRA from 28.5% to more than 50%. U.S. GAAP requires a remeasurement to fair value of non-controlling shares when a controlling interest is obtained. As a result of the transaction, Moody's recorded a gain of $0.36 per share in the second quarter of 2014. Non-GAAP EPS of $1.12, which excludes the ICRA gain, increased 12% from $1 in the prior year period. Turning to year-to-date performance. Revenue for the first six months of 2014 was $1.6 billion, a 10% increase from the first six months of 2013.
Revenue at Moody's Investors Service was $1.1 billion for the first six months of 2014, an increase of 8% from a year ago. Moody's Analytics revenue for the first half of 2014 of $493 million was 15% higher than the prior year period. Operating expenses for the first six months of 2014 were $896 million, up 5% from 2013. Operating income of $745 million increased 18% from $631 million in 2013. Adjusted operating income was $790 million, a 17% increase from the prior year period. First half 2013 operating expenses, operating margin, and adjusted operating margin all include a first quarter litigation settlement charge. Diluted earnings per share of $2.47 for the first six months of 2014, which included $0.36 related to the ICRA gain, increased 35% from the prior year period, which included a litigation settlement charge of $0.14.
Excluding the 2014 ICRA gain and the 2013 litigation settlement charge, diluted earnings per share of $2.11 for the first six months of 2013 grew 7% year-over-year. 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 $874 million. Foreign currency translation favorably impacted revenue by 2%. Second quarter U.S. revenue increased 13% to $461 million, while revenue outside the U.S. grew 19% to $412 million and represented 47% of Moody's total revenue for the quarter. Global recurring revenue grew 12% to $412 million and represented 47% of total revenue, down from 49% 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 $622 million, up 16% from the prior year period. U.S. MIS revenue of $353 million increased 13% from the prior year period. MIS revenue generated outside the U.S. of $269 million increased 20% and represented 43% of total ratings revenue. Foreign currency translation favorably impacted MIS revenue by 1%. Moving now to the lines of business for MIS. First, global corporate finance revenue in the second quarter increased 22% from the year ago period to $321 million, primarily reflecting strong rated bank loan and speculative-grade bond issuance in both the U.S. and Europe. U.S. and non-U.S. corporate finance revenue was up 20% and 24% respectively.
Second, global structured finance revenue for the second quarter was $111 million, an increase of 14% from the prior year period, primarily reflecting increased ratings of CLOs in the U.S. and Europe. U.S. and non-U.S. revenue increased 17% and 8% respectively against the prior year period. Third, global financial institutions revenue of $92 million increased 9% from the second quarter of 2013. Despite an increase in issuance activity from U.S. banks, U.S. revenue declined 4% year-over-year due to a shift in issuance mix. Non-U.S. revenue increased 19% against the prior year period as a result of increased issuance from banks across all regions. Fourth, global public project and infrastructure finance revenue increased 6% year-over-year to $98 million. U.S. revenue was down 2%, primarily due to continued weakness in public finance issuance, which was partially offset by increased infrastructure issuance.
Turning now to Moody's Analytics. Global revenue for Moody's Analytics of $252 million was up 15% for the second quarter of 2013. Foreign currency translation favorably impacted MA revenue by 3%. U.S. revenue grew by 14% year-over-year to $109 million. Non-U.S. revenue of $143 million increased by 16% from the prior year period and represented 57% of total Moody's Analytics revenue. More than 65% of 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 $145 million increased 11% from the prior year period, driven by strong performance in credit research and content licensing.
RD&A represented 57% of total MA revenue, our customer retention rate remains strong in the mid-90s% range. RD&A U.S. revenue was up 9%, and non-U.S. revenue was up 13% as compared to the second quarter of 2013. Second, global enterprise risk solutions, or ERS, revenue of $67 million grew 12% against the prior year period due to growth in subscription revenue and services revenue. ERS U.S. and non-U.S. revenue was up 13% and 11%, respectively, against the same period last year. As we've noted in the past, due to the variable nature of project timing and completion, ERS revenue remains subject to quarterly volatility. Trailing 12-month revenue and sales for ERS have increased 8% and 15%, respectively. Finally, global professional services grew 41% to $40 million, primarily reflecting the December 2013 acquisition of Amba Investment Services. U.S. and non-U.S. revenue increased 67% and 33%, respectively, year-over-year.
Turning now to expenses. Moody's second quarter expenses increased 14% to $462 million compared to the second quarter of 2013. The increase was primarily due to higher compensation and real estate expense attributable to increased headcount, increased incentive compensation, and acquisition-related costs. Foreign currency translation unfavorably impacted operating expenses by 1% for the quarter. Moody's reported operating margin for the quarter was 47.1%, up 70 basis points from 46.4% in the second quarter of 2013. Adjusted operating margin was 49.7% for the quarter, up 20 basis points from the 49.5% for the same period last year. Moody's effective tax rate for the quarter was 33.1%, compared with 32.2% for the prior year period. Now I'll provide an update on capital allocation.
During the second quarter of 2014, Moody's repurchased 3.2 million shares at a total cost of $258 million, or an average of $80.39 per share, and issued 0.7 million shares under employee stock-based compensation plans. Outstanding shares as of June 30th, 2014, were 211.2 million, reflecting a 4% decline from a year earlier. As of June 30th, 2014, Moody's had $1.3 billion of share repurchase authority remaining under its current program. At quarter end, Moody's had $2.1 billion of outstanding debt and $1 billion of additional debt capacity available under its revolving credit facility. Total cash equivalents, restricted cash, and short-term investments at quarter end were $2 billion, an increase of $308 million from a year earlier. As of June 30th, 2014, approximately 69% of our cash holdings were maintained outside the U.S.
Free cash flow for the first half of 2014 of $419 million increased $68 million or 19% from the same period a year ago. Finally, on July 7th, 2014, Moody's issued a total of $750 million of debt. Including $450 million of five-year notes with a coupon of 2.75%, and $300 million of 30-year notes with a coupon of 5.25%. We intend to use the proceeds to redeem our senior unsecured notes due in 2015, totaling $300 million, as well as for general corporate purposes. With that, I'll turn the call back over to Ray.
Thanks, Linda. I'll conclude this morning's prepared comments by discussing the changes to our full year guidance for 2014. Additional details on Moody's guidance are included in our second quarter 2014 earnings press release, which can be found on 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. The company now expects full year 2014 revenue to grow in the low double-digit percent range.
Full year 2014 operating expenses are now projected to increase in the high single-digit % range. These expenses now include costs related to our acquisitions of a majority stake in ICRA and of WebEquity, as well as additional incentive compensation. We now expect operating expenses to ramp between $80 million and $90 million from the first quarter to the fourth quarter of 2014. Full year 2014 non-GAAP EPS guidance is in the range of $3.90 to $4. Our non-GAAP EPS guidance now includes costs related to our acquisitions of the majority stake in ICRA and of WebEquity, and additional incentive compensation and financing costs associated with our July 2014 bond offering. Global MIS revenue for the full year 2014 is now expected to increase in the high single-digit % range.
Within the U.S., MIS revenue is now expected to increase in the mid-single digit % range, while non-U.S. revenue is expected to increase in the low teens % range. Corporate Finance revenue is now projected to grow in the low double-digit % range. Revenue from structured finance is now expected to grow approximately 10%. Financial Institutions revenue is now expected to grow in the low single-digit % range. With regard to Moody's controlling stake in ICRA, the company will report ICRA's operating results within Moody's Investors Service on a three-month lag, beginning in the fourth quarter of 2014. ICRA is expected to contribute approximately $12 million of revenue to MIS in the fourth quarter. For Moody's Analytics, full year 2014 revenue is now expected to increase in the mid-teens % range.
Including the acquisition of WebEquity, revenue for enterprise risk solutions is now expected to grow in the mid-teens % range. Professional services revenue, including Amba Investment Services, is now projected to grow approximately 40%. This concludes our prepared remarks. Joining us for the question and answer session are Michel Madelain, the President and Chief Operating Officer of Moody's Investors Service, and Mark Almeida, President of Moody's Analytics, who'll be pleased to take any questions that you have.
Thank you. If you'd like to ask a question at this time, you may do so 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. Once again, it is star one to signal. We'll take our first question from Tim McHugh with William Blair & Company.
Yes, thanks. I guess just wanted to ask a little bit more about the higher expenses you expect for this year. How much of that, or can you help us break that down a little bit in terms of added incentive comp versus any drag from upfront expenses related to ICRA and how much dilution from WebEquity? I guess I'm trying to understand how much that's offsetting what was better than expected performance this quarter and the impact on the full year guidance.
Sure, Tim, it's Linda. Let's first look at second quarter expense increase versus last year. For the second quarter, our expenses were $57 million higher than last year, up 14%, and I'll give you the reasons for why that is. The largest component of that is compensation increases, and that was about $42 million. Compensation for new hires over the course of the year was about $15 million. Merit and stock-based compensation for the staff we have was about $12 million. The expenses related to the Amba acquisition we did last year were about $8 million. Non-comp was about $15 million, and that included acquisition, some other expenses of about $6.5 million, and some occupancy changes of $4.1 million. You may remember we have leased two additional floors and a third coming online in this building here.
That would be the reason for the higher expenses second quarter-over-second quarter. As we move to the end of the year, we had said expenses were going to ramp about $55 million. We're adding another 30-ish to that. We said $80 million-$90 million expense ramp between the first quarter and the fourth quarter. The additions would be the cost of the acquisitions at about $20 million. We're thinking incentive comp will add about another four, and expenses that we're spending in the second half rather than what we thought were going to come in the first half are about six-ish. That adds about $30 million to the expense ramp in the second half. Now, just to be really clear, under GAAP, deal costs are expensed as they're incurred. Regardless of when or whether deals close.
As we look at deals, and when we incur deal expenses, we expense those, and we've included those. Revenues come a little bit more slowly, but that's U.S. GAAP. We're looking at a three-month lag on revenues for ICRA, which as we disclose in our table in the press release, will give us about $12 million in the fourth quarter of this year for ICRA. Also purchase accounting adds haircuts to revenues. We're in the position of recognizing the expenses right away and the revenues a little bit later. Now in ICRA, we're taking a three-month lag because ICRA reports on Indian GAAP, and we've always reported ICRA's results on a three-month lag. We have to convert those to U.S. GAAP, and it takes a quarter to do that transition. We will see the ICRA revenues coming on in the fourth quarter.
Again, we closed the deal on June 26th, so you see the expenses, and the WebEquity deal closed on July 17th. You can think through what the acquisition costs mean there. Generally, we're thinking it's about $0.05-ish for the deal activity and about $0.04 for the financing that we did. Your call as to whether you want to think about that, those are GAAP expenses as to whether you want to think about those in the run rate or not. Hope that thoroughly answers everything that you were interested in.
That's great. That's very helpful. I guess just one follow-up to make sure I understand it correctly. On ICRA, you're talking about you right away have to recognize any of the transaction or upfront expenses. Do you have to recognize the operating expense from ICRA right away, or is that tied to when you start recognizing the revenue that's delayed by three months as well?
That's delayed by three months as well. Exactly.
What we're recognizing immediately were the transaction-related costs.
Can I just on ERS, I think trailing 12 months sales activity was up 9% last quarter, up 15% this quarter is a pretty healthy step up. I don't know if the comp got easier or I guess as you rolled forward a quarter, or did you see a particular pickup in sales activity that I should read into that?
I'll let Mark Almeida address that.
Yeah. We had a very strong quarter on sales this past quarter, we had a number of very good-sized transactions, we had one very large transaction as well. It wasn't a question of an easy comp so much as just very strong results in the quarter.
Just as we normally comment, we expect to see quarterly volatility, that's why, as you have done, we encourage looking at the 12-month period.
Okay. Can you give any color on, is this stress testing related type of work that you're winning with? I guess in particular, you said there's one very large deal. Can you give us any more color on what type of project that is?
Stress testing continues to be good for us. We're doing a lot of business there, and we have a healthy pipeline. Just in the normal course business, we're having a lot of continued success. The large transaction that we did really has nothing to do with stress testing. It's just a very big project that a particular customer is undertaking, and they selected us to take the lead on that project.
Okay. Thank you.
We'll go next to Joseph Foresi with Janney Montgomery Scott.
Hi. With the change in the issuance business, has your expectations for the overall environment, particularly on the interest rate side, changed at all? I know that they've dipped down recently. Do you expect them to be lower to exit this year, or how should we think about the relationship there?
Yeah. I know Linda has some detail on this, but just as an introductory comment, yes, rates have been lower than we were anticipating earlier in the year. We think they are probably going to remain lower than we had expected through the second half. There are a number of factors relating to that, including the flight to quality in respect of some of the geopolitical tensions that we're seeing. We're going to be paying close attention to what's happening, not just with benchmark rates, but also spreads. The good news is we continue to see low default rates, and that's keeping spreads reasonably tight. Linda, I don't know if you wanted to add some commentary.
Sure, Joe. If you want to look at the U.S. issuance trends, I'll talk about investment-grade bonds and then high-yield bonds and leverage loans just very quickly. The second quarter obviously was very strong for investment-grade bond issuance, and for the first half of the year in the U.S., again, we're running about $600 billion of issuance, which was up about 10% year-over-year. For the full year, expecting $950 or $1 billion of investment-grade issuance in the U.S., which will be about flat. June was very busy. July slows down because of earnings blackouts. We think the technical backdrop remains positive. M&A activity is picking up, and it's running at a pace that we haven't seen since 2007. For corporates, refinancing high coupon bonds remains very popular. We expect that the pipeline will come back to strength in August and September.
For high-yield bonds, we're running about $200 billion in the U.S., which is about flat year-over-year, and expecting a little bit less than that in the back half of the year, maybe $150 billion. Full year to be about $330 billion, which is flat year-over-year. A little bit of volatility in June because of the headlines. We do see that, as Ray said, rates remain attractive. The pipeline is about average at this point for high-yield bonds. In leveraged loans, about $270 billion for the first half of the year, down 5%. For the full year, expecting about $425 billion, which is also down 5% year-over-year. Calendar is very active there, and majority of that activity is related to M&A issuance. We have seen for the first time some outflows from loan funds, but that's offset by very heavy issuance of Collateralized Loan Obligations.
Issuance for the first half there has been $67 billion, compared to $46 billion for the same time last year. The pipeline continues to be, as I said, above average due to that LBO and M&A activity in leveraged loans. A bit of a mixed bag and the traditional sort of July earnings blackout lag here. Rates remain pretty attractive, and as Ray said, default levels are low.
Got it. Very helpful. You went through a very thorough and also helpful discussion of costs and expenses and how they're looking for the going forward. Are ICRA and WebEquity diluted to margins in the short term, and do you expect to have them step up to corporate average if that is so? I understand that the expenses versus the revenues are a little bit mixed in those businesses, but I'm trying to get a feel of what exactly the dilution is from them, if any. How long it would take to get them back to company average.
Sure. The EPS impact for this year, yes, ICRA is a little bit dilutive. You might want to call that about $0.03, and WebEquity about $0.02. Again, you might want to think about how you want to factor that in.
Okay. Just so, am I making the assumption that we're going to get them up to corporate average over an extended period of time?
From a margin perspective, first of all, WebEquity is a small business. It's a business we think is a nice fit, but it is small. It will not be margin dilutive to Moody's Analytics. ICRA, while it is an attractive business, does not have the same margin that Moody's Investors Service does. There will be a modest drag from ICRA. Again, it is a nicely profitable business.
Got it. Okay, last question from me. Obviously, some news out regarding the regulatory environment for one of your competitors. Any updates you can give on that or any thoughts that you think are appropriate? Thank you.
Not much to say. All we know is what has been discussed in the public market. Really nothing to add to what you would've already read.
Thanks.
We'll go next to Andre Benjamin with Goldman Sachs.
Thank you. Good morning. Two quick questions. First, how much of the second quarter reported revenue growth in Corporate Finance was driven by more of the volume growth in high yield and investment grades, which we can observe versus other things that are a little bit harder for us to see publicly, like pricing or new customers or additional revenue from other stuff like monitoring?
Yeah. Obviously volumes were strong in the second quarter. We also did have a pickup in other non-issuance related components of revenue. That includes price. It includes monitoring fees, which relate to relationships that we have grown, new rating relationships that we've grown in the prior year and earlier in this year. The pipeline of new rating relationships has remained strong, both in the U.S. and in Europe this year. It's a multifaceted growth story for the corporate sector.
Andre, it's Linda. The specifics in the Corporate Finance area, investment grade revenue was $63 million, which is 20% of the whole line, and that was up 5% from last year. Spec-grade bonds, $77 million, was 24% of the total corporate line. That was up 36% from last year's $57 million. Bank loans, about $76 million from last year's $53, represents about 24% of the total line, and that's up 43% from last year. Other accounts, about $105 million, up from $93 million last year. That's 33% of the total line and up 13% from last year. What we see here is a pretty white hot speculative grade market. As we go into the second half, we've toned that down a touch because this is really remarkable speculative grade issuance. We expect that favorable conditions will continue. Will they be to this degree and this strong?
We have to think about that a little bit for the back half of the year. I don't know if Ray or Michel would like to comment further on that.
No, the only comment I would add is just reinforcing Linda's remarks. We don't see anything on the horizon that looks like it's going to have a chilling effect on the market. The likelihood that it's going to remain at the pace we saw in the second quarter in spec grade, we don't think that's the central case. Michel, if you have anything to add, please do.
Nothing to add, Ray.
Okay. Thank you.
Thanks. A quick follow-up, a little bit longer term. We've run some numbers on a set of representative U.S. companies and see that leverage ratios as measured by net debt to EBITDA are at the lowest level in about 15 years. I guess, as you talk to your CEO customers, do you feel like we're likely to remain in more of a structurally lower band for leverage going forward? Could we potentially be at something like a cyclical trough where all the risk aversion and political issues could go away, and as the economy improves, we can actually see people meaningfully adding leverage again?
Certainly, I think what we're seeing from a geopolitical standpoint breeds caution. Beyond that, looking longer term and assuming that that is resolved in some non-catastrophic way. We look primarily, I think, to economic momentum around the world and the business confidence associated with strong economic momentum and what that does for borrowing for M&A and Capital Expenditure as opposed to the refinancing that we've been seeing. If there's a re-leveraging, I think it's going to come off of greater global business confidence.
Andre, it's Linda. We saw a pretty strong durable goods number this morning, which is encouraging. The CapEx picture has been mixed, though. It has strengthened a bit, but it's very sector specific. We've probably peaked in terms of CapEx additions for the natural resources industries as commodity prices have come off. For other industries, they're sort of looking to increase their CapEx spending. Overall, it's moved a bit, but perhaps not as robustly as it could, and we'll see if this durable goods order number leads that up, which would be helpful to us.
Thank you.
We'll go next to William Bird with FBR.
Good morning. I was wondering if you could talk a little bit about Europe. What kind of trends are you seeing? How is the pace of disintermediation going? Secondly, could you talk about just your plans for deploying the excess $450 million that you raised in July? Thank you.
Okay. Michel, would you like to comment on what you're seeing in Europe?
Yes. Well, I think we continue to see the trends we described in prior quarters. Disintermediation continue to run through. We see new issues coming to market. We see a high level of activity across the board, basically in CFG, and especially around high yield, basically, and also bank loans, which is really the speculative segment of the marketplace. Nothing is putting that in question. As you know, the ECB is launching a program of a targeted LTRO program, which will provide liquidity to banks that are lending to the marketplace. That will provide some more lending capacity on the part of the banks, but we don't expect that to really derail that momentum.
Thanks, Michel.
Bill, it's Linda. You're right. We did a $750 million bond deal a while back, and $300 million of that we are looking to redeem a private placement tenure piece of paper that comes due in 2015 with a 4.98 coupon on that. Once we do that, the rest, the remaining $450, will be used for general corporate purposes. The usual stuff, working capital, CapEx, acquisitions, repayment of other debt and share repo. Interestingly on the deal that we did, we had a five-year piece and a 30-year piece. We were trying to access markets and investors that we hadn't been able to achieve before. The deal was massively oversubscribed, and we were able to tighten the pricing. We were very pleased about that and pleased that we're able to access the debt markets at rates which have been very attractive for us.
We're just doing some management here in terms of how we're handling our various pieces of debt. We would note that our bonds are trading very tightly. In fact, as compared to one of our competitors, maybe even 100 basis points tighter. We're pleased with how all that's going.
Linda, could you give us the actual number on the incentive comp accrual in the quarter?
Yes. Hang on just one second, Bill, while we find that. Incentive compensation for the second quarter was $44 million, up from $34 million last year. About a $10 million increase. Stock-based compensation moved up as well, $20 million versus $16 million last year, or $4 million heavier. Salaries and benefits were $238 million versus $210 million last year, which is $28 million heavier or 13% higher. That's the incentive compensation view. We've been asked a lot about that incentive compensation. The main driver of incentive compensation is really operating income. Keep in mind, operating income was up 17%. If we are able to put up good operating income, we do increase our incentive compensation pool. Note that we do not get paid incentive compensation on that ICRA gain. That is not included.
We have to have real results in order for us to have the incentive compensation pool move up. For the rest of the year, because we'll probably get that question, we had asked people to look at maybe $35 million a quarter for incentive compensation, and it's probably better if you bump that up to more like $40 per quarter for the rest of the year. That help?
Great. Thank you. Thanks a lot.
Sure.
We'll go next to Manav Patnaik with Barclays.
Yeah. Hi, good. Just one clarification on all the cost details that you gave out. The $0.05 impact from the deal cost and then the $0.04 from the financing, that was just for the second quarter, and then for the remainder of the year, call it another $0.06 from the acquisition cost. Did I get that right?
No, the $0.05 and the $0.04 are built into our full year outlook of $3.90 to $4.
Okay, fine. That's great. Linda, like you talked about the different components in Corporate Finance, just in Structured Finance, can you just talk about the CLO market, I guess seems like what's driving most of the growth, and how that breaks out and just some commentary there?
Yeah, sure. I'll go ahead and do the other two sectors after that as well, because we usually get asked. Let's start with Structured. Structured for the quarter is $110 million. Asset-Backed Security is about $24 million. That was actually down a little bit from last year's second quarter, about $25.5 million. Asset-Backed are about 22% of the Structured line. RMBS, about $20 million, up from last year's about $19 million, and it's about 18% of the Structured line. Commercial Real Estate is at $30 million, about flat to last year's $30 million as well, and that's 27% of the Structured line. Structured Credit, you're right about this, Manav, is $37 million. That's 34% of the Structured line. It's up from $22 million last year or about a 70% increase. Structured Credit CLOs have been very helpful to us on the Structured Finance line.
Would you like me to just go ahead and go through FIG and PPIF-
Yeah, sure
Manav?
Okay.
FIG was $92 million for the quarter, and that was up from $84 million last year. Banking, about $64 million, up from $57 million last year. It's about an 11% increase, and banking's close to 70% of the FIG line. Insurance, $24 million, up from $23 million last year, pretty flat. It's about 26% of the whole FIG line. Management of investments, about $4 million. Pretty flattish from last year, and that's only 5% of the FIG line. PPIF, we did $98 million in the second quarter, and Public Finance and sovereigns, about $40 million. That's actually down from last year's $43.5 million. PFG and sovereigns represents 41% of the PPIF line. Structured munis, $4.3 million, exactly flat to last year, and that's 4% of the line. Some project in infrastructure at about $54 million, up from last year's $45 million.
It's a 20% increase, and that represents 55% of the PPIF line. You can see we've had good growth, particularly as we mentioned in the script, on the project and infrastructure line. The structured credit CLO line. Banks, a little bit weaker than perhaps because of the nature of the issuance, the big banks issuing. We've talked about the very strong results in the spec grade lines in corporates.
Okay, thanks a lot. Just one more on the cash balance. The percentage held offshore ticked up nicely, at least from what I had for the full year of 2013. Clearly you guys are raising some debt in the U.S. and so forth. Just any thoughts around how you're going to manage that international cash or use it?
Sure. Your observation's right. For the second quarter, we had about $600 million of cash in the U.S. at the end of the second quarter, which keep in mind was before we did the bond deal. Internationally, we had about a billion for $1.368 billion of international cash. That's 70%. We did the U.S. bond deal, of course, to help our U.S. cash position, and we run a little bit heavier in terms of cash being generated by the international part of the business. How will we manage it? We manage it to support international acquisition opportunity, and we are happy with the balance that we have given that our business is about 50% outside the U.S.
We're fine with the balance that we have, and we have plenty of U.S. cash to support our dividends and our share buybacks and liquidity needs that we have in the U.S. as well.
Okay. Thanks a lot, guys.
Sure.
We'll go next to Peter Appert with Piper Jaffray.
Thanks. Linda, just staying on structured finance for a sec, I think this is the best quarter you guys have done from a revenue perspective since the financial crisis. I'm wondering if you guys read anything into this in terms of beyond CLOs, or are we at an inflection point in terms of life in the structured finance market?
Peter, it's Ray. I'll start. We obviously were very pleased with Structured for the quarter. It is really being driven by the CLO market, both in the U.S. and in Europe. We've seen growth in some other areas, but that really is the dominant driver of growth in CLO in Structured at this point. The commercial real estate sector has been pretty good. We still are not seeing a lot of activity in RMBS, in covered bonds in Europe, student loans. Some of the areas that we saw pre-financial crisis are still not showing much of a pulse. I think that's going to moderate the rate of growth in structured finance, although I think we are going to continue to see growth in that area. I would not anticipate any kind of explosive growth coming out of Structured at this point.
Peter, as I noted, RMBS has actually been down year-over-year, and I think it was noted in this morning's economic results that new housing sales were down. We continue to see perhaps a weaker housing market than might be hoped for. Around the world, though, we do have governments starting to talk about the need to get the securitization market for housing, for residential mortgage-backed securities functioning again. That is something that those conversations have also taken place in Europe. Perhaps Michel might want to comment a little bit on covered bonds, which we also include in this line, and RMBS potential in Europe as well. Michel, did you want to say a few words?
Well, you're right. I think there's a lot of discussion in Europe about restarting the securitization market, creating the right conditions to do that. The ECB, the Bank of England, a number of governments and policymakers are focusing on that. The reality is that, as Ray said, it remains a very anemic market at the moment. Covered bond also is facing the challenge of the fact that banks have very ample source of funding, and actually the ECB is adding to that. I think politically, and there's a lot of discussion around that, but the dynamics of the market remains behind what we've seen in the past. The CLO is similar to the U.S., has been really the major driver of the improvement together with better activity in RMBS, actually in Europe.
That's helpful. Thank you.
Thanks, Michel.
Linda, can you remind me the relative profitability of the different asset classes for you guys? I think the impression in the market is that high-yield issuance is generally going to be more profitable for you, probably structured finance as well. I'm wondering if some of your conservatism with regard to the second half guidance might be a function of just this mix issue and an expectation of weaker trends in high-yield.
Peter, we price a little bit higher for speculative-grade ratings. That's because that is a tremendous amount of credit work required in bringing those ratings to the market. Whether it's more profitable is a different question. We try to run profitability pretty similarly across all of our business lines. I'm not sure it's much more profitable. Structured finance is not more profitable. That's a bit of an urban myth we've had in place for many years here at Moody's. I think the issue on the back half of the year, and I'll let Ray comment on this, is just really what we are thinking about regarding speculative-grade activity. As we said, we've taken guidance up. On the spec-grade front, we had a white-hot second quarter. We're cautious, as we're usually cautious about whether that pace can continue.
I'll let Ray correct anything I said wrong.
The only thing I would add is, which I think you already know, Peter, our structured business and the spec-grade business are more transaction-based businesses as opposed to recurring revenue businesses. We do enjoy the benefit of high volume periods, but there's a bit more volatility when issuance activity slows. We see much less of that in investment grade, in financial institutions. It is a characteristic of the spec grade and structured markets.
That's helpful. Thanks very much.
We'll go next to Craig Huber with Huber Research Partners.
Yes. Hi there. I got a few questions, I guess. First, your total headcount of your company, what is it today, and then what % is it up from a year ago?
Sure. The answer, excluding the acquisitions, Craig, is that headcount is up 10% year-over-year. If you include the acquisitions, I think we've got in the press release, we're running approximately 9,500 people now. Most of our acquisitions have been in the revenue-generating businesses, and we're being very careful in the shared services part of the business to ensure that we have our more routine functions in lower-cost jurisdictions. Headcount's up to about 9,500 with everything considered. Without the acquisitions, we've had about a 10% increase.
Secondly, you gave a lot of detail on costs and stuff, but I'm just curious, back in the second quarter, were there any one-time costs that you can quantify for us that were in the quarter? Any deal-related transaction costs you maybe quantify, stuff like that?
Craig, we don't really want to get into that. I think we had talked about looking forward, there's sort of $0.05 there from acquisitions and deal costs and $0.04 from the financing costs. We don't want to tell the analysts what to think. If you want to think about that as part of the run rate, please do that, but we're very cautious to make sure that we give the GAAP numbers and give those first, so that those are well understood. I don't think we want to get into the particular cents associated with various deals.
Was there anything else, Linda, that you'd want to highlight other than this $0.05 and $0.04 that made you keep your full-year EPS guidance the same?
I think that's most of it, Craig. We'll see where we get to, or the next time we'll be speaking to the markets, Investor Day, September 30th. We'll take another look at that time. From a GAAP perspective, we do have to include these costs. Again, the analysts can choose a different path if that's what they'd prefer to do. Ray, I don't know if you have anything else you want to add.
No. That's it.
Sorry, a couple more if I could. The WebEquity revenues here, can you just quantify that for us for modeling purposes? You said it was small.
Right. I'll turn it over to Mark. I'm not sure we had disclosed that.
Yeah, we haven't really talked about WebEquity in any detail because that wasn't a second quarter event, just closed last week. It is, as I said before, we like the company quite a bit. We like its fit in Moody's Analytics. The position it gives us with the smaller U.S. banks, which has not been an area that we have been as involved in historically. Their loan origination solutions for smaller banks is a very nice fit, we think, strategically, but again, it's a small company. The materiality of the revenue is not there.
Craig, one other thing that we should note on the run rate for the expenses. We said expenses, the estimated tax rate is 33%, and in the first half of the year, we ran a little bit lower. By math, it's going to potentially run a little bit higher in the back half of the year. In the first half of the year, we had a resolution of some international tax matters, and in the second half, we are expecting a somewhat higher rate absent any other of these individually resolved matters. We do expect for the tax rate to average 33% for the year, but again, it ran a little lower in the first half, so that means by the math, it would have to run a little higher in the back half. Make sure that you factor that in as well.
Also, if I could ask, your professional services, what was the revenue growth there excluding the Amba transaction?
It was almost entirely from the acquisition.
Okay. I guess my last question, if I could sneak this in. Your main competitor, S&P, obviously has been in the news a lot here the last 48 hours with their Wells notice. I'm just curious, Ray or Linda, whoever wants to answer this, how often does a company like yours have to make significant methodology or criteria changes to your ratings methodology? Because that's something that the government seems to be focusing on with S&P right now. I'm just curious if you could just talk broadly about that, how often do you have to make it in a material way?
Well, I don't think there is. I mean, we review our methodologies annually. There's not a schedule for changing methodologies. Frankly, that is really dependent on the ratings performance, how well our ratings accuracy is being measured and external events. If there are changes in regulation, in some industry structure that dictates a review of the methodology, we obviously will do that. I don't even know what the pace of change in methodologies has been historically other than we review them regularly.
Yeah, I'm just curious, you're suggesting it's pretty rare that you have to change the criteria methodologies.
No. We've changed methodologies in some sectors this year, we did so last year as well. Minor changes are more common than material changes. As I said, we're not trying to set a pace for change so much as making sure that we are responsive to what's happening in the market and what we think is the ongoing quality of the methodologies that we're using.
Great. Thank you.
We'll go next to Doug Arthur with Evercore.
Great. Just one question. A clarification, Ray. On the $12 million that you're expecting to recognize from ICRA in the fourth quarter, is that in the revised MIS guidance, or is that extraneous to that?
That is in the revised MIS guidance.
Okay, great. Thank you.
We'll go next to Patrick O'Shaughnessy with Raymond James.
Hey, good morning. My first question is, where do you think we are in terms of M&A being a meaningful contributor to bond issuance? I ask because although we've seen M&A pick up, the commentary from a lot of the advisory shops is, we're seeing announcements right now, but a lot of deal closings are late this year. They're going to be 2015 events. Do you think there's still a lot more room to go in terms of bond issuance related to M&A?
I think there is potentially. I take your point that the announcements predate debt financing. We're pretty optimistic about what we anticipate on the M&A front. Obviously, we'll keep our eye on that. Linda, I don't know if you had anything else you wanted to add to that.
That's one of the factors, Patrick, that encourages us about the back half of the year and also next year as well. If you look in our investor deck, there's a chart in there that correlates M&A issuance to bond issuance, which might help you out. As we said, M&A deals have been running at the fastest pace for the first half since 2007. It's been quite a strong surge, and obviously companies are aware of low interest rates and also record-high equity prices, so that creates a really terrific deal environment. We've been talking about this now for quite a while, but we're finally seeing it, which is terrific. The point that you make that some of this financing will spill over into 2015 is correct, and that will be helpful to us next year as well.
Then if you can remind me, where does M&A financing typically fall? I would imagine a lot of the sponsored financing is going to be high yield, but corporate M&A, is that mostly investment grade or is it a mix? Where has that historically fallen?
You're correct that most sponsored deals are generally high-yield deals, and they can either fall in bank bond deals or loan deals. Private equity firms can even kind of run it up to the day of the financing, decide what the balance is going to be between those two. For big corporates, those probably would tend toward investment-grade issuance. You're right about that. Particularly the strategics, as they're acquiring, that would generally be investment-grade financing.
Yeah.
I don't know if Ray wants to add anything.
I was just going to say, the financials would tend towards the spec grade and the strategics would tend towards the investment grade.
All right. That's helpful. Thank you. Lastly from me, how's the tone of your interactions with the SEC been recently, if you can provide any commentary there? I ask because the SEC's enforcement director has made some public comments about how they might be more active with their oversight of ratings agencies. I just want to know if anything that he said has been reflected in kind of the tone of your interactions with the SEC.
As you would imagine, we have frequent contact with the SEC staff through their inspection and review procedures, the Office of Credit Ratings. I would characterize those interactions as being constructive. There are things that the SEC expects us to do from a process standpoint, from a reporting standpoint, and we do everything we can to meet those expectations. I would not characterize the relationship as hostile in any way. I think it is constructive.
All right, great. Thank you.
We'll go next to Edward Atorino with Benchmark.
Ed, good morning. Could you review the numbers you gave on the bank loan ratings? That's a category that sort of exploded in recent years, and it's now a pretty good chunk of business. Could you give the % of business, something like that, year-over-year growth, the margins on the business?
Sure, Ed. I'll give you the growth. We're less interested in talking about margins.
Okay.
Last year, bank loans were $53 million of revenue for us, and this year, it's close to $76 million. It's an increase of almost $23 million or 43%. You're right. That line is a healthy contributor to our corporate finance business. As Ray said, a lot of that is driven by merger and acquisition activities. We also note that because investors like floating rate paper right now, given their concerns about potential interest rate increases, bank loans are really where the action is, primarily in the U.S., but also to some degree in Europe. You're right.
Europe too, yeah.
It does. It's a high point.
Yeah, Ed, I would-
I didn't think the banks were big enough to do that. Anyway.
I would just underscore the comment that we are seeing strong activity in Europe in the bank loan area. That is a line that in years past I would not have highlighted.
Yep
It wasn't large enough to be worth citing. It has come on very strongly and is a nice part of the corporate business now.
Is it a totally separate or is it sort of displacing traditional issuance, if you know what I mean?
I think it's really part of the disintermediation story.
Got you. Yeah.
The ratings on the bank loans makes it easier to syndicate and transfer those loans. Yes, there is a trade-off between rated bank loans and bonds, particularly spec-grade bonds. As Linda said, depending on appetites for fixed rate versus floating rate paper and the decisions about whether to enter the bond market or remain in a banking relationship by a corporate drive that mix over time.
You may have given this. Are they priced about the same as bonds or premium or discount in terms of your rate that you charge?
The speculative grade area is priced a little bit higher, Ed.
They're in the speculative grade area, yeah. Got you.
For the most part, yes.
Yes.
Thanks very much.
We'll go next to Bill Warmington with Wells Fargo.
Good afternoon, everyone. A question for you now that your operating margins have reached the mid-40s. I think you've made some comments in the past about trade-offs between investing that incremental profit going forward into revenue growth versus margin expansion. If you could share your thoughts with us on that.
Sure. I'll take a crack. It's Linda, and then Ray can take a shot at it as well. We are executing on margin expansion here at Moody's. As I read in the prepared remarks, the operating margin for the first quarter was 47.1%. That was up 70 basis points from last year's 46.4%. Again, this is not a marketing campaign and not promises. We are expanding our margin, and 70 basis points I would submit is pretty healthy year-over-year. We have said that over the mid to longer term, we were looking to be in the low to mid-40s and we continue to be happy with that view. We do want to invest back in our businesses. As you can see, our businesses are performing really well. We're very pleased with the growth rates we're putting up.
Our shareholders are 80% growth and GARP holders, and they've told us they want top-line growth above everything else, but we are able to have margin expansion as well. I think we feel pretty happy about this balance, and our shareholders do as well from what we can see, and Ray may have some other thoughts.
It's just, obviously it's going to be influenced by mix, the pace of growth at Moody's Analytics versus Moody's Investors Service, and the pace of growth inside the U.S. versus outside the U.S., particularly whether it's in developed markets or emerging markets. Where we see opportunity for top-line, we're going to go after that. We're still going to be prudent in managing the margin. We want the top-line growth.
Yeah. We'll talk a little bit more about this when we get to Investor Day. Quite frankly, we haven't started our process yet to think about what, if anything, we might say or change at Investor Day, potentially we can talk about that. We would note we're running this business very efficiently, and we're very pleased with the progress we've been able to make on our margin line. I think that pretty much covers it.
A question for you on Copal, on the knowledge process outsourcing side. If you could comment on what you're seeing for the pace of outsourcing at the U.S. banks, whether you're seeing that increase or decrease, stay the same?
Copal Amba has very nice margins, and Moody's-like growth rate is what we've said in the past. We feel that we're in the right place at the right time, having very high-end knowledge process outsourcing capabilities. I think it'd be fair to say there's very active dialogue going on with just about all of the U.S. banks who are looking to cut costs. You can see those stories every day in the press. Also looking to increase their return on equity. It is a terrific business for us to have, particularly at this point in the cycle, and I'll see if Ray or Mark want to say anything else.
No. I think that about does it from my perspective.
Well, thank you very much. Appreciate it.
Sure.
That will conclude our question and answer session. I'd like to turn the conference back over to Raymond McDaniel for any closing or additional remarks.
Okay. Just quickly before we end the call, I want to announce that we will host our annual Investor Day on Tuesday, September 30th, here in New York. Attendance is by invitation only, and the event will be webcast. Further details will be provided on our investor relations website, ir.moodys.com, as we get closer to the event. Thank you for joining the call today, and we look forward to speaking to you again at Investor Day and then in October.
This concludes Moody's second quarter 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.