Good morning, and welcome to S&P Global's Second Quarter 2018 Earnings Conference Call. I'd like to inform you that this call is being for broadcast. All participants are in a listen only mode. We will open the conference to questions and answers after the presentation and instructions will follow at that time. To access the webcast and slides, go to investor.
Spglobal.com. That is investor. Spglobal.com and click on the link for the quarterly earnings webcast. I would now like to introduce Mr. Chip Merritt, Vice President of Investor Relations for S&P Global.
Sir, you may begin.
Good morning. Thank you for joining S&P Global's earnings call. Presenting on this morning's call are Doug Peterson, President and CEO and Ewout Steenbergen, Executive Vice President and Chief Financial Officer. This morning, we issued a news release with our Q2 2018 results. If you need a copy of the release and financial schedules, they can be downloaded at investor.
Sdglobals.com. In today's earnings release and during the conference call, we'll provide an adjusted financial information. This information is provided to enable investors to make meaningful comparisons of the Corporation's operating performance between periods and to view the Corporation's business from the same perspective as management's. The earnings release contains exhibits that reconcile the difference between the non GAAP measures and the comparable financial measures calculated in accordance with U. S.
GAAP. Before we begin, I need to provide certain cautionary remarks about forward looking statements. Except for historical information, the matters discussed in the teleconference may contain forward looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, including projections, estimates and descriptions of future events. Any such statements are based on current expectations and current economic conditions and are subject to risks and uncertainties that may cause actual results to differ materially from results anticipated in these forward looking statements. In this regard, we direct listeners to the cautionary statements contained in our Form 10ks, 10 Qs and other periodic reports filed with the U.
S. Securities and Exchange Commission. I would also like to call your attention to European regulations. Any investor who has or expects to obtain ownership of 5% or more of SMB Global should give me a call to better understand the impact of this legislation on the investor and potentially the company. We're aware that we do have some media representatives with us on the call.
However, this call is intended for investors, and we would ask that questions from the media be directed to Jason Feuchtwanger at 212-438-1247. At this time, I would like to turn the call over to Doug Peterson. Doug?
Thank you, Chip. Good morning, everyone, and welcome to the call. Global GDP continues to be strong, but trade tensions, Brexit, MiFID II and the unwinding of quantitative easing present uncertainty and challenges. In the meantime, however, companies continue to look to S and P Global to provide the data analytics benchmarks, insights and trade flow information to navigate market events. But let me begin today's call with the 2nd quarter highlights.
The company delivered 26 percent adjusted EPS growth. Our adjusted effective tax rate declined 500 basis points to 23.9 percent as a result of U. S. Tax reform. In the second quarter, we generated $488,000,000 in free cash flow, excluding certain items.
Our $1,000,000,000 accelerated share repurchase program continues and we returned $126,000,000 in dividends. Our 2018 adjusted EPS guidance remains unchanged. And we expanded our differentiated customer content with the acquisition of RateWatch and we incorporated new data sets from Crunchbase. Taking a closer look at the financial results, the company reported 7% revenue growth and 6% on an organic basis. Excluding the impact of foreign exchange, however, organic revenue increased 5%.
Our adjusted operating profit margin increased 230 basis points to 49.1%. We delivered 26% adjusted diluted EPS growth. Please note that our EPS included favorable impacts of $0.04 from ForEx and $0.01 from the tax benefit from stock option exercises. Ewout will provide more information on these in a moment. What I'd like to do next is provide some more color on the current and future drivers of our businesses.
When tracking bond issuance in the quarter, we always point out that where issuance takes place, which type of issuance and the size of the deals make a difference in the revenue we realize. Global issuance in the 2nd quarter, excluding sovereign debt, decreased 3%. Structured finance, however, continued to be strong. Geographically, issuance in the U. S.
Decreased 12% in the 2nd quarter, with investment grade decreasing 19%, high yield declining 30%, public finance down 12%. But structured finance increased 5% due primarily to strength at RMBS and ABS. In Europe, issuance increased 9% in the quarter with investment grade increasing 10%, high yield declining 29% and structured finance increasing 29% with strength in covered bonds and CLOs. Reverse Yankee bonds in Europe are also getting traction from a very small base. Reverse Yankee bonds are bonds issued in another country by a U.
S. Company. As Europe offers lower cost financing, issuers are beginning to take advantage. In June, single B rated bonds in Europe offered average financing of 150 basis points cheaper than the U. S.
This differential is beginning to entice U. S. Issuers. In Asia, issuance decreased 4%. The vast majority of Asian issuance, however, is made up of local China debt that we don't currently rate.
As you'll see later, there is never perfect correlation between issuance and revenue because of bank loans, frequent issuer programs, pricing and a number of non transaction related revenue. In fact, despite a decline in bond issuance during the quarter, ratings revenue increased. One area of financing that continues to grow is leveraged loans. During April, the inventory of U. S.
Leveraged loans surpassed $1,000,000,000,000 for the first time. It has outgrown uninterrupted every year since hitting a low in 2010. In addition, the loan market now comprises more than 1,000 issuers, an increase of more than 50% since 2010. To meet their financing needs, speculative grade companies can choose whether to utilize the leveraged loan market or the high yield bond market as conditions warrant. Bank loan ratings are primarily issued on leveraged loans typically rated BB plus or lower.
Our revenue growth from bank loan ratings has exceeded the growth of the market as the percentage of bank loans that we rate has increased. Our 2nd quarter bank loan rating revenue is $121,000,000 a 22% increase over the $99,000,000 recorded a year ago. There is some downside, however. The sharp increase in new issue supply, a whopping $102,000,000,000 of loan paper entered the secondary market in May June, has pushed spreads higher, eliminating potential savings from most repricing exercises. In fact, June repricing volume of only $16,000,000,000 was the lowest monthly total in the past year and July is on a pace to be even lower.
Turning to S and P Dow Jones Indices. At the end of June, we released the annual survey of assets. This chart depicts the highlights of that survey. Most importantly, there was a 17% increase in assets globally that track indices managed by S and P Dow Jones Indices to $13,700,000,000,000 This includes $8,900,000,000,000 in active money that is benchmarked against our indices and $4,800,000,000,000 in passive money that is invested in products indexed to our indices. Numerous indices support the $4,800,000,000,000 I'd like to highlight 3 categories.
Clearly, the S and P 500 is the largest of all products with $3,400,000,000,000 in assets. These assets increased 15% in the past calendar year. Smart Beta, the 2nd category, which has $234,000,000,000 in assets is up 27% and fixed income, the 3rd category, with $45,000,000,000 in assets, is up 11%. Agricultural commodities derivatives have historically been settled with physical delivery. Following success in the energy market, increasingly cash settled derivatives are being created.
Last December, CME launched the 1st cash settled futures in agriculture based on Platts price benchmark for Russian wheat and Ukrainian corn. As you can see from this chart, it has been a very successful launch with over 55,000 contracts traded in the 1st 6 months. Based on this success, last week, CME introduced option contracts for Black Sea wheat and corn futures linked to the same benchmark. Turning to other developments in the quarter, we continue to innovate, expand differentiated content and create new products. In June, the company acquired RateWatch.
RateWatch is a subscription business that provides differentiated data and analytics for the banking sector, including custom reports on bank deposits, loans, fees and other product data. RateWatch was founded in 1989 and was acquired by The Street in 2007. It will be integrated into market intelligence and will be a great addition to our existing bank data offering. In April, Crunchbase data on almost 400,000 private companies became available on the market intelligence platform with the help of Kensho. Crunchbase utilizes a community of thousands of contributors to crowdsource data.
True Cost, a leader in carbon environmental data and risk analytics, has launched the True Cost Sustainable Development Goal or SDG evaluation tool. The tool is designed to help companies to identify business risks and opportunities aligned with United Nations' SDGs. Over 9,000 companies and investors with more than $4,000,000,000,000 in assets have pledged their support to the SDGs. S and P Dow Jones Indices launched the S and P 500 Carbon Price Risk 2,030 Adjusted Index. It's designed to measure the performance of the constituent companies of the S and P 500, reweighted to account for the potential specific impact of 2,030 carbon prices on constituent stock prices.
Adjusting market valuations to account for the future possible cost of carbon emissions seeks to address potential company specific financial value at risk attributable to carbon rather than looking purely at quantity of emissions. Now let me turn the call over to Ewout to provide more specifics on our business results for the quarter. Thank you.
Thank you, Doug, and good morning to everyone on the call. This morning, I would like to provide additional color around our Q2 results. We reported solid operating results and Doug already discussed the revenue growth and the increase in adjusted diluted EPS. I would like to touch on a few other line items. 1st, adjusted corporate unallocated operating loss increased $3,000,000 due to $6,000,000 associated with Kensho and a $3,000,000 reduction in excess real estate in New York and London.
2nd, I want to complement our employees for their efforts in outstanding year over year expense control. It is important that we work to ensure that our revenue growth outpaces our expense growth. An increase of only 2% in adjusted total expenses, is a result of numerous technology projects, lower incentives and productivity improvements. 3rd, interest expense decreased $11,000,000 primarily due to the resolution of New York State tax audits. FIN 48 requires us to accrue interest and penalties associated with potential tax payments.
Based on the resolution of these items, we refer to interest expense accruals, resulting in lower interest expense in the quarter. 4th, the most impactful item during the quarter was U. S. Tax reform, which resulted in a dramatic reduction in our adjusted effective tax rate. We are continuing to review and evaluate new provisions of the Tax Cuts and Jobs Act.
During the Q2, we recorded a $9,000,000 provision for the global intangible low tax income tax for all of the first half of 2018, we are continuing to monitor regulatory guidance and interpretations of the new legislation. Finally, while it doesn't impact our financial statements, I want to update you on another tax matter. Some of you may recall that in the Q2 conference call last year, we discussed that the IRS issued a 30 day letter proposing to increase the company's federal income tax for the 2015 tax year by approximately $242,000,000 The increase related primarily to the IRS's proposed disallowance of claimed tax deductions for certain amounts paid in 2015 to settle lawsuits by 19 states and the District of Columbia. We stated at the time that we vigorously disagreed with the proposed adjustment and are pleased to report that we have reached a settlement with the IRS in April for $14,000,000 that was fully reserved. We continue to estimate that the EPS impact from the tax benefit associated with stock based compensation will increase 2018 EPS by $0.10 to $0.20 depending on SPTI's share price and option exercise activity.
EPS is also impacted whenever the fair market value of employee stock grants ad vesting differs from the grant price. The impact is recorded as an adjustment in tax expense. During the Q2, we recorded a reduction in tax expenses that improved 2nd quarter adjusted EPS by $0.01 Foreign exchange rates had a $12,000,000 positive impact on the company's revenue and a $16,000,000 positive impact on adjusted operating profit or about $0.04 per share in the Q2. The bulk of the impact was in the ratings segment. Ratings revenue was primarily impacted by the euro and the British pound.
There were 3 adjustments to operating profit this quarter. The first was related to our legal settlement reserve. As we stated back in May, the company settled the final significant financial crisis litigation. We are increasing our reserve by $73,000,000 this quarter to meet this settlement obligation. 2nd is an item that will be ongoing for the next 3 years related to retention expenses for certain Kensho employees.
And finally, there was $33,000,000 in pre tax due related amortization expense. In the Q2, every business segment contributed to gains in revenue, adjusted operating profit and adjusted operating profit margin. This was truly a solid quarter of operating performance by each of our business segments. Now turning to the individual business segments, let's start with Ratings. As you may recall, Ratings revenue grew 10% in the Q2 of 2017.
Against this strong prior year comparison, ratings revenue increased 4% this quarter or 2% excluding a favorable impact from ForEx. Adjusted operating profit increased 12%, while the adjusted operating margin increased 400 basis points to 57.1%. The decline in expenses was primarily due to lower incentive accruals and productivity improvements. As we have said in the past, we managed the Ratings business on a rolling 4 quarters basis and you can see on that basis, the adjusted operating margin increased 380 basis points. Non transaction revenue increased 7% due primarily to growth in fees associated with surveillance, new entity ratings and rating evaluation service fees.
Transaction revenue increased 1% as a 22% increase in bank loan ratings revenue offset a decline in bond rating revenue. If you look at ratings revenue by its various markets, you can see the greatest gains were in structured finance as has been the case for 5 straight quarters. Structured finance revenue increased primarily due to strong CLO and RMBS activity. Corporate revenue increased despite a decline in issuance. The only category where revenue declined was government due to the 12% decline in U.
S. Public finance issuance that Doug mentioned. Turning to indices. Revenue increased 13% with higher ETF and mutual fund AUM, greater OTC transactions and strong exchange traded derivatives activity. This strong growth in revenue led to a 15% increase in adjusted operating profit and a 70 basis points increase in adjusted operating profit margin to 65.8%.
Asset linked fees which are principally derived from ETFs, mutual funds and certain OTC derivatives increased 18% driven by a 21% increase in average ETF AUM. Exchange traded derivative revenue rose 17%, healthy growth but not near the record setting volume experienced in the Q1. Subscription revenue declined 4% due to a delay in contract renewals as a result of a change in administrative processes. We believe these contracts will be renewed later this year. The trend of assets moving into passive investments continued in the 2nd quarter with the exchange traded products industry reaching net inflows of $119,000,000,000 The quarter ending ETF AUM tied to our indices totaled $1,382,000,000,000 up 20% versus the Q2 of 2017.
As the chart shows, this was the result of $119,000,000,000 of net inflows and $107,000,000,000 of market appreciation over the last 12 months. The Q2 average AUM associated with our indices increased 21% year over year. This is a better proxy for revenue changes than the quarter end figures. Exchange traded derivatives volume was mixed during the Q2. Key contracts include S and P 500 index Options, which grew 18% fixed futures and options activity, which decreased 25%.
Lastly, activity at the CME Equity Complex increased 14%. Let me now turn to Market Intelligence. In the 2nd quarter, revenue increased 8%, organic revenue increased 7% and excludes the acquisitions of Panjiva, which is increasingly cited in the media for its trade flow data and newly acquired RateWatch. Adjusted operating profit improved 9%. Our adjusted operating margin increased 40 basis points.
There was some concern among investors during the Q1 when we reported an adjusted operating profit margin of 29.5%. We hope that the improvement to 32.8% will allay those concerns. Looking more deeply at market intelligence revenue, all three components delivered solid revenue growth. Desktop products grew 5%, data management solutions increased 11%, leading growth from market intelligence Risk services grew 8% with growth in Ratings Express, Ratings Direct, Credit Pro and other credit analytics and risk solutions. Here I want to briefly review some business highlights.
We have discussed the movement to enterprise wide commercial agreements for our desktop products, but it's important to understand that outside the desktop business, essentially all products were sold as enterprise wide commercial agreements already. With our emphasis on instituting enterprise wide commercial agreements for our desktop business, by the end of the second quarter approximately 75% of former Capital IQ desktop customers had been converted. Also during the quarter, we realized a 13% increase in Market Intelligence active desktop users versus the prior period. As for the new market intelligence platform, progress continues. We have been systematically rolling out the new platform to investment banking clients and rounding out the offering with additional Capital IQ content.
In conjunction with Kensho, work is on the way to enhance screening and search capabilities. And we are building unique user interfaces with functionality tailored to different customer types because we know that what a corporate treasurer wants to see is different than what an equity analyst wants to see. As we roll out future releases, we will offer flexibility for clients to preview and test platform changes as well as switch back and forth between platform versions to gain comfort with new enhancements. Turning to Platts, revenue increased 7% in the 2nd quarter, including about 1 percentage point of the growth that was timing related. The high single digit growth in our core subscription business was diluted by weakness in Global Trading Services revenue.
Global Trading Services generally represents less than 10% of Platts revenue. In the Q2, it experienced mid single digit declines as derivative trading continued to be weak in certain high sulfur fuel oil products. After reporting a 48% adjusted operating profit margin in the Q1 of this year, margins rebounded to 49.9 percent in the 2nd quarter, an increase of 190 basis points over the Q2 of 2017 and coincidentally the Q1 of this year. Revenue growth outpaced a 3% increase in adjusted expenses. If you look at Platts revenue by its 4 primary markets, you can see that petroleum and power and gas make up the majority of the business.
All 4 categories delivered revenue growth during the quarter with petrochemicals and metals and ag leading the way with 20% and 10% growth respectively. Now turning to our capital position, our cash balance was reduced by approximately $1,000,000,000 from the end of 2017 due to the accelerated share repurchase agreement that we initiated in the Q1. Our debt increased approximately $100,000,000 as we issued a $500,000,000 30 year bond to redeem $400,000,000 in maturing debt. Our debt coverage, as measured by adjusted growth leverage to adjusted EBITDA, remains 1.9 times. Year to date free cash flow excluding certain items was $787,000,000 This was an increase of $152,000,000 versus the first half of twenty seventeen and was due to higher net income from revenue growth, lower tax rate as well as improved working capital.
As for return of capital, the $1,000,000,000 ASR initiated in the Q1 continues. In addition, we paid $126,000,000 in dividends during the Q2. While we do not plan to provide headcount information quarterly, we thought that you might find this information useful. In the past year and a half, our headcount increased 4%. Excluding acquisitions and divestitures, headcount increased 3%, while organic revenue grew 13% in 2017 and 7% in the first half of twenty eighteen.
The largest increase in employees was in corporate. This category increased primarily due to transfers from the businesses to centers of excellence, the Kensho acquisition and in sourcing of certain corporate functions like recruiting and accounting business support. The costs associated with most of these additions are allocated out to the businesses and are not included in corporate unallocated. Now I will review our 2018 guidance. This slide depicts our previous GAAP guidance and our new GAAP guidance.
Please keep in mind that our guidance reflects current spot market ForEx rates. The difference from our previous guidance is highlighted on this slide. The only change is that we are lowering our interest expense guidance by $10,000,000 Diluted EPS guidance remains unchanged. This slide shows our adjusted guidance. The only change is that we are lowering our interest expense guidance by $10,000,000 Adjusted diluted EPS guidance remains unchanged as we expect the tax on global intangible low tax income to push our tax rate to the high end of guidance.
While our tax rate guidance remains 21% to 22.5%, We expect that the 3rd quarter tax rate to be similar to the 2nd quarter tax rate and then decline in the 4th quarter when annual restricted stock grants fast creating a stock based compensation tax benefit. In addition, as you model the Q3 of 2018, remember that the Q3 of 2017 we recorded a $0.14 benefit to EPS as a result of exceptionally high level of stock option exercises. We can't expect that this will occur again in the Q3 of this year. We are pleased with our Q2 results and our guidance reflects our continued expectation that 2018 will be a very strong year for the company. With that, let me turn the call back over to Chip for your questions.
Thank
you,
Operator, we'll now take our first question.
Thank you. This question comes from Hanzah Mazari from Macquarie Capital. You may ask your
My first question is just on the Ratings business. And Doug, I think you mentioned sort of offsets in terms of if issuance is down, ratings can still grow. Maybe if you could frame for us at what level of issuance declines does the ratings business sort of not grow? Is it sort of double digit issuance needs to decline double digits? Just any sensitivity to issuance and how to think about cyclicality of that business?
Well, Hamzah, first of all, thank you for the question and welcome to the call. I don't know if I can always project exactly what that point would be, but let me just give you the dynamics and the different pieces that we look at. Clearly, issuance is very important for us. And as you saw during the quarter, issuance in the United States was very weak except for structured finance. On the corporate side, it was down 18% with corporates and financials and public finance overall.
So it was quite a weak quarter. But remember that we have 2 components of revenue. We have transaction fees, which are and could be directly impacted by this, but we also have non transaction fees, which includes things like RES. It includes the fees that we get for surveillance. It also includes new issuer fees when we're able to get new issuers to come to market, etcetera.
And so we look at the total all the components. And as you saw this quarter, despite a weak issuance overall down 3% in total for the entire market, we were able to increase our revenues 4%. So answering your question a bit more specifically, I don't have a number. I haven't run a sensitivity analysis. None of us have that would get you to what that number is.
But we do think that we have flexibility to also flex some of our expenses if we were to see a really, really large downturn.
Very helpful. And then my second question, like it's over levered to the U. S. Maybe if you could talk about just strategy to grow that business globally and then how you're thinking about that? Thank you.
Yes. That's something that's really important for us and not just for market intelligence, but for every single one of our businesses to respond to the opportunities globally as different markets become more We have 2 We have 2 components of our businesses across the board and I'll come a little bit more specifically to market intelligence. Some of our businesses have traditionally done all of their billing in U. S. Dollars out of the U.
S. And for example, in the index business, we have always billed traditionally here and you end up with maybe it's not so easy to always exactly explain where was the client from because it ends up being U. S. Sourced income. And that's one aspect I wanted to mention that we're always looking at to see how we can ensure that we're identifying the source of our customers and over time be able to show the components international.
In Market Intelligence, the combination of Cap IQ and SNL, first of all, the U. S. Capital markets and the banking markets, they are the largest in the world. They're the most sophisticated, the most the largest with the most number of transactions, whether it's M and A, it's the size of the banking markets, the equity markets, etcetera. And so we would tend to think that that business would be larger here than the rest of the world.
But we do have high growth around the world, especially in Western Europe and Asia. Those are the 2 markets where we see a lot of take up of market intelligence services, especially as there's more and more M and A taking places in those markets and as the capital markets get more sophisticated. But you're right, the center of gravity of Mi is in the United States, but we're increasingly investing overseas and seeing much more growth there.
The next question comes from Alex Kramm from UBS. Your line is now open.
Hey, good morning, everyone. So on the rating side, love to EBIT, I guess, for you to parse out the margin a little bit more. I know you made some comments already on the comp accruals and also the employee numbers were very helpful. But if you think about it from a year over year perspective, I mean how much of the increase is really efficiency gains versus maybe mix that you can talk about that may have favorably impacted margin? And then, of course, how much opportunities do you still think there's left for from an efficiency side and what are you focused on?
Thanks.
Yes, Alex. Good morning. To put the ratings results in perspective, 57% margin for the quarter on the trailing 12 month basis around 55%. During our Investor Day, we have indicated that our aspirational direction for Ratings margins is high 50s. So we have some nice way to go there.
But as you have seen a pretty significant step up in terms of margins this quarter on a trailing 12 month basis 3 80 basis points and we're very pleased to see that particularly in a quarter where revenue growth is a little bit light. So revenue was up 3.7 percent, but if you exclude FX, it was up 2.2%. And expenses were down in fact 5.1%, but excluding FX 3.1% down. So still a gap between revenue growth and expense decline on a basis excluding FX impact of over 5% points, so a very positive development. Why are expenses going down for Ratings?
You see there the impact of some of the restructuring actions that we have taken last year. You might recall the restructuring actions that we explained in the commercial organization, in the analytical organization. So clearly headcount reductions are helping there. We're also seeing that incentive compensation accruals are lower this year than previous year and we start to see the benefit from some of the technology investments, the efficiency opportunities. So we're able to handle more volume without adding a lot of headcounts.
So overall those are the main drivers we see in ratings. We expect that we will continue with those drivers in the future hence the aspirational margin targets of high 50s in the future.
The next question comes from Toni Kap from Morgan Stanley. You may ask your question.
Hi, good morning. Market Intelligence had a slight revenue deceleration in the quarter with desktop a little bit slower. Is there anything to read into that from the shift to enterprise pricing and maybe taking less revenue dollars upfront in order to drive higher usage? Just any thoughts on that, that would be helpful.
Tony, hi, good morning. This is Doug. I don't think you should read anything into it. This was a period where we have been, as you know, engaged in moving our contracts to the enterprise wide pricing. We're making good progress there, but there's clearly a set of clients left that we will be getting to between now and 2019.
Most of the contracts that we moved to enterprise pricing were the largest ones or the ones that had the fortunate convenience that the contracts were expiring. Some of those that are left where we have not gone into any sort of negotiation yet on the upside there are larger contracts in some cases where they have multiple dates or multiple. We already had multi year contracts in place before that we're now going to be able to go in as those expire. So I didn't read anything into it. We think that the leading indicator of the growth of users up 13% is a positive leading indicator for us.
I'm not saying that that you should build that into your models, but it's a good leading indicator to us over the time. And as we continue to move everyone to enterprise contracts, we're getting toward the end of that. We're at about 75%. We have about 25% to go, but those 25% to go are going to be some of the harder ones or longer to get those in place.
Okay, that's helpful. And then I just wanted to ask my follow-up on Platts. With 7% growth in the quarter, is this mid to high single digits growth sort of a level you'd expect for the foreseeable future just given the high subscription mix? And if Global Trading Services were to turn around, what kind of upside could you see in that business? Thanks.
Tony, good morning. This is Ewout. As I mentioned during the prepared remarks, of the 7% growth in revenues for Platts, there was about 1% of increase that was more one time in nature. There was some catch up on some subscription revenue. So if you think about modeling this out in the future, you should not take that into account that 1% more one time revenue.
Also with respect to the global trading services, we don't expect that to rebound in the near term. That has to do with the specific nature of derivative tradings on certain high sulfur oil fuel products that we see declining. That has mostly to do with marine fuel where in 2020 we will see a prohibition of high fuel oil products in the marine business. So derivatives trading is already coming down And we expect over time low sulfur oilfield products derivatives trading to come up, but not in the near term. So that would be our expectation.
But overall, we are very pleased that in the core business of Platts, the core price benchmarking subscription business, Platts is really doing well and we see they are very steady and solid growth.
Thanks.
The next question comes from Manav Patnaik from Barclays. You may ask your question.
Thank you. Good morning, gentlemen. Maybe I can just follow-up on the Cap IQ desktop piece. So the last three quarters, it has decelerated. I think it was 9, 7 and now 5.
I guess outside of just maybe some of the friction of transitioning to enterprise, I mean, are you seeing pressures on the client side, more people cutting costs, missed it impact, stuff like that? I was hoping you could give us some color there.
There is when you come to those sorts of topics, obviously, when we're negotiating with clients, there's always going to be a give and take on different themes related to the circumstances of clients. And we do hear people saying that MiFID II is increasing their costs. So we might hear them talk about the size of their businesses as they downsize. But we see, as you can see overall, the approach that we take to building these enterprise wide contracts lead to higher usage and higher users and that is fundamental to our overall relationship and how we think about the long term pricing of these contracts. But remember that we also are coming off of some very strong growth.
So some of the comparables quarter on quarter, year on year also have been a little bit difficult on some of the quarters. But we do see that this is a business that is it's still growing. There's high demand and high interest in our products. And some of the pricing on desktop is also made up on the feeds and the data services as you see some of the some of our customers are moving away from analysts to modeling and sometimes we're able to if that if there is the case, we can substitute over into the data services products.
And Manav, if I may build on Dirk's answer, I think you should also look at this in perspective of the whole industry. I think the growth numbers we are reporting are by far exceeding any other player in the industry. So we're still clearly a net winner of market share at this point in time. The other additional perspective I want to share is the conversion to enterprise wide agreements. What we see happening now is that the contracts that we had in the past that were on an annual basis, those come up in a normal course calendar and have been converted to enterprise wide contracts.
But we also had a set of contracts that had multiyear terms and those will come up more slowly in the future because again the natural calendar when those multiyear contracts are expiring will be out in the future. So that's why the slowdown from the current 70% to 75% to 100% that's what you should expect. But there's no specific underlying reason besides that these are now the more multiyear contracts that we need to convert and that takes obviously a little bit more time.
Got it. That's helpful. And then my second question is just on the index subscription piece, the slowdown you talked about due to administrative process changes. I imagine that's on your end, but I guess does that mean in the 3rd Q4 there will be a catch up which will make that growth look above normal?
Yes, Manav, what is happening here is we made some changes earlier this year in administrative processes, and also we moved some of the billing and contracting on those contracts to another provider, another administrator. It's one of our partners. There is a bit of an administrative backlog. They are sending out new contracts and only when the new contracts are signed we can send out the bills. So therefore from an accounting perspective we cannot recognize that revenue.
But this is purely a technical administrative matter and we expect to see that catch up again in the second half of this year. So yes, we expect this to normalize and there is no commercial disagreement or commercial matter behind it. It's purely administrative.
All right. Thank you, guys.
Thank you.
The next question comes from Jeff Silber from BMO Capital Markets. You may ask your question.
Thanks so much. Just wanted to circle back to Market Intelligence again. You had mentioned or you highlighted the fact that margins went up year over year in the second quarter versus, I guess, the lower margins that you saw in the Q1. Was there something going on differently between 1Q and 2Q? And what should we expect going forward?
Thanks.
Jeff, this is Ewout. We highlighted during our Q1 earnings call that there were certain specific expense items that were more timing related that should reverse during the course of 2018 or should not recur during other quarters of 2018. Therefore, we always expected that margins of Market Intelligence would improve during the next few quarters. And what we have said last quarter was we expect overall a year over year margin improvement for Market Intelligence that 2018 as a whole should be better than 2017 on a margin basis. So basically in line with that commitment and promise to our investors that is basically what we are delivering this quarter and we expect that to continue for the next few quarters.
So overall that commitment remains.
All right, great. And then appreciate that reminder. In terms of your overall guidance, except for the item you highlighted on the interest expense, it didn't really change despite the fact that you've really outperformed the first half of the year. Are you being overly conservative? Should we expect a slowdown in the second half of the year?
If you can give us a little bit more color on that, we appreciate it. Thanks.
Yes. Our guidance is, of course, always middle of the road, neither aggressive nor conservative. So that's how you should always interpret this. There is indeed a couple of elements that go in a positive and into a negative direction, but are basically offsetting each other. We expect that interest line to be a little lower as we have indicated.
At the same time, we expect the tax rate to be more at the high end of the range that we have indicated before. So the 2 are therefore more or less offsetting and therefore we're still very comfortable to continue to affirm our EPS guidance raise as we have done this morning.
Thanks so much.
Next question comes from Peter Appert with Piper Jaffray. You may ask your question.
Thank you. Good morning. Doug, you mentioned that the bank loan market had gotten a little bit weaker late in the quarter. I wonder if that has any continuing implications for the second half or even more broadly, if you could just give your thoughts about outlook for issuance activity in the second half?
Okay, good. In fact, if there was a little confusion, I'm glad you asked the question. There's 2 components to the bank loan market. 1 is the issuance of bank loans. And those are, as I mentioned, many cases, those could either go to the high yield bond market or they could go to the bank loan market.
And that market is incredibly strong. And that's where you see the volume, that's where you see the crossing the $1,000,000,000,000 mark for the inventory that's outstanding, etcetera. That continues to be very strong. As you see, there's a lot of M and A activity. The part that I said that was a little bit weak is the refinancing.
There had been a period where bank loans had been issued the last prior 2 or 3 years as rates and spreads had been coming in and getting tighter and tighter, there was many of the some of the activity was of issuers who are going back and repricing their bank loans. When a bank loan re prices, we get a small fee. It's not the same kind of the fee you get when you have an initial transaction. But that was that's the component of the market that is a little bit weak. But the reason it's weak is because the initial issuance is so strong and it's basically crowding out the ability of issuers to go to the market, to tap refinancing or repricing, sorry, not refinancing, repricing.
Got it. Excellent. Thank you. And then maybe just an update on the Kinshaw transaction in terms of momentum you're seeing there? And Ewout, I think you talked about 3 years of incentive payments.
Can you quantify what those will be?
Yes, Peter, let me take the first answer the second question you asked and answer that first with respect to the incentive compensation. So if you look at the transaction consideration for Kensho, a part was in cash and a part was in shares. And we deliberately paid a part in shares to get maximum alignment, particularly with the employee shareholders. And those are being amortized over time. What we are doing in our results is any equity grants that were over and above what should be assumed normal compensation are pulled out as a performance correction on a non GAAP basis and all equity grants that are more considered normal course are kept in our normal operating expenses and results on a performance basis.
So if you look at $12,000,000 of Kensho retention related expenses that were pulled out was basically the expense related to those excess equity grants. That number should come down over time. That's more because of the accounting. We use an accelerating accounting method. So over the next 3 years that should slowly come down and 3 years from now that particular expense line item should completely disappear.
But then you see that Kensho itself had a normal course about $11,000,000 of expenses that we have in our non GAAP results as well as approximately $5,000,000 of revenues that we have recorded. On your first question about how the Kensho implementation and transaction is going,
let me step in a little bit. We have an incredible amount of excitement both internally in the company as well as from the markets since we purchased Kensho. We have instituted a very thorough systematic approach to what I would call integration, even though you know that we're not integrating the company. It has to do with ensuring that the resources of Kensho are deployed against the best opportunities where they can add value across the company. That means that every division has some type of work going on, probably most of it's in market intelligence.
And the kind of work begins at the beginning of bringing data, data ingestion, data linking. It also involves projects in the middle part of our workflow that has to do with creating products, analytics, adding value or enhancing the analytics that we have. And then at the front end, the delivery end of our businesses with search and visualization and other tools. So we're very pleased with the progress. You saw that there were a couple of things during the quarter when we added the 400,000 private company information from Crunchbase.
We were able to do that utilizing Kensho technology. It was accelerated from something that would have taken about 6 months to a couple of weeks. And we've recently put a tab on the market intelligence platform, which has a Kensho lab on it, where you can see 2 different products or they're not products yet, but I guess you can call them pilots or demos of some of the things you can do with Kensho. One of them is for alternative credit indicators and the other is for analyzing the commercial real estate market. So we're very pleased with the progress, much more to come.
And thank you for the question.
Thank you, sir. If I may just add one other element to that, we will later this year come back to you about the economic benefit we will have from all of those projects. So we're setting up a value capture methodology. So expect later this year that we get back to you and of course all your colleagues and investors with more specifics about what do we really get out of that and the value enhancement from those projects.
Thanks.
Next question comes from Craig Huber with Huber Research Partners. You may ask your question.
Thank you. Doug, my first question, can you just appreciate your thoughts on the bank loans earlier, but can you just give us a little bit further idea what you guys are thinking of the bank loan market for back half of this year in terms of what you're sensing there is going to happen?
What we're sensing in the bank loan market right now is just based on where we are with the current banking environment and financial market environment. First of all, one of the key factors which we're watching very carefully are spreads and rates. And you do have some shift from bank loan market as well as the high yield market moving to Europe. I mentioned in my prepared comments that we've seen the reverse Yankee bond trend starting where there's more and more companies going to Europe to raise funds. Clearly, with the U.
S. 10 year yield at almost 3%, around 2.9% and the German 10 year yield at about 0.4%. That differential of 240 basis points, 2.50 basis points means that sometimes raising funds in Europe is a lot more interesting. So in terms of where people might be raising funds, we see some differences there. But the key driver of the loan activity as well as the high yield bond activity is much more linked to market activity, M and A, investments in factories, etcetera.
The only negative factor, which we're obviously watching very carefully is just will there be any impact on global growth from some of the exogenous factors like trade wars and things like that. I mean, it was encouraging yesterday to see that the U. S. And the EU are going to go to the table to negotiate the trade conditions. I would hope that at some point we can get to the same place with China.
But underlying market conditions are still very strong. They're very robust. Banks have a lot of capital. The investment community is looking for places to invest, but we have seen some more volatility in the meantime. But as of now, we don't have any specific indicators that would change our outlook for the rest of the year on bank loans.
And then also, the new platform you're in the process of rolling out for Capital IQ, when do you think that will be fully deployed in the U. S. And what little bit you have outside the U. S?
We will
go step by step, customer group by customer group, persona by persona. That needs a lot of support, hand holding, explanation because some data might be in another place. It is important that our customers can find it. We don't want to confront them solely from one day to the other with a new platform and they are lost. So that needs a lot of support from our sales force and our whole market intelligence organization.
So therefore we do this in a step by step basis because it's very important we take our customers along the way with that transition.
One thing I would mention is that, we've seen the success of the conversion of what was the S and L product to the Mi platform. And so that gives us the ability to understand what were the needs of the customers along the way. And as Ewout said, this is a systematic approach over the next couple of years and it will have a conversion of Cap IQ users and then also include certain risk products. And we're very encouraged that the platform itself, whether it continues with the name MI or it's an S and P Global platform or re skinned for other products like Platts, etcetera, that the kind of expertise we're getting from the technology is going to be beneficial to the entire company.
The next question is from Joseph Foresi with Cantor Fitzgerald. You may ask your question.
Hi, guys. This is Mike Reed on for Joe. I was wondering if you think this period was more normal for the exchange traded derivative growth or could it spike back up or just too volatile to tell?
Mike, that is actually very hard to tell because as you've seen the 3 different categories and groups, some are up, some are down. You could say there is still a lot of market volatility in the world, but in fact fixed contracts came down in terms of volume. So this is in fact an interesting situation that you could say there's quite some volatility in fixed derivatives volume trading period over period. So it's very
hard
to tell. We definitely think the Q1 was more an exception with the very high volumes. So that would be only what we would expect to see recurring if there's really heightened tension in the world. But otherwise, it's very hard to predict.
Mike, this is Doug. This is just an anecdote for myself personally. I watch VIX. I think that the VIX is a good indicator of market volatility to begin with. But second, that is one of the major ETDs.
And the more volatility there is in the market, the more trading there is, the more likely that the ETD revenues are going up. So when if you go back last year, the VIX had been kind of locked into a very low level below 10 for many quarters and then it started popping up again. It got as high as into the 30s over a couple of weeks. And that's typically the leading indicator that I watch to see how I think the ETD revenue is going to be coming out.
Okay. Thanks for the color on that. And then just quickly, do you think there'll be any impact to numbers at all this year from RateWatch?
I would say relatively modest. It will help of course with some revenue impact, but there will be some integration expenses as well and some synergies that we'll be able to achieve over time. So normally that will be about a year to 2 years that we will be able to take the full economic benefit of this acquisition. We are very enthusiastic about this acquisition. We think it helps with a new set of customers particularly community banks in the U.
S. So we're very happy that we added that set of customers to market intelligence, but expect the benefits to see that slowly coming in over the next year to 2 years. That's probably the best expectation.
All right. Thanks, guys.
Thanks.
Next question is from Tim McHugh from William Blair and Company. You may ask your question.
Hi, this is Trevor Romeo on for Tim. Thanks for your questions. First of all, revenue for structured products has been growing double digits for 5 straight quarters now, as you mentioned. The global economy is a bit stronger and we've had some positive regulatory changes for structured projects lately, but do you think that level of strength sustainable going forward, particularly as comparisons will start to get tougher in the next few quarters?
Just to be clear, are you talking about structured finance in ratings?
Yes.
Okay. Well, typically, when we see this kind of strength coming in one product, it's from the banking sector and other sectors, which are taking advantage of the securitization markets and access to capital there. And I don't know I don't want to project going forward exactly where issuance is going to be coming from, But we've seen the strength in structured finance. A lot of it has been related to banks wanting to manage their balance sheets as they've been managing capital levels and they've been going to tap the AFS markets for credit card receivables, auto receivables, things like that as a balance sheet management tool. And then you see a lot of special purpose vehicles in CMBS and other areas.
But this has just been a period where the capital markets were drawn towards structured finance. It's been it has been growing every quarter. But I don't one of the things that I do, obviously, almost continuously, but definitely at the quarter end is look very carefully at all of the different sources of issuance around the world. And one thing I can tell you that every quarter, the components of where growth is coming changes from quarter to quarter.
Okay, thanks. And then just wanted to touch on any geographic differences you're seeing for Platts. Revenue was kind of flattish in this quarter in the U. S, but grew double digits internationally. So is there anything you'd point out that drove the strong international growth that didn't necessarily happen in the U.
S?
Yes. Overall, Platts is in general our most international business. In fact, they are headquartered in London and in fact their business is very international in Europe and particularly in Asia. And we are very happy to see growth sales in Asia doing very well, but also Europe is strong. I think that has just to do with the saturation of saturation levels of the markets.
We see a lot of economic activity in Asia and we're clearly taking the benefit for our Platts business. So overall, we would expect to see that continuing. And actually coming back to an earlier question, this is clearly as part of our strategy to more actively grow our activities outside of the U. S.
Got it.
Thank you very much.
The next question is from Vincent Hung with Autonomous. Your line is now open.
Hi. On Market Intelligence, so for those you've converted to enterprise wide pricing already, is there anything you can share in terms of usage trends you're seeing with CAF IQ? Because I'm just trying to get a sense of where the stickiness is building with the new users.
I think that would be a great question for us to take up on some future calls. I don't have enough of a granular view on that to give you an answer right now, because we typically once we move to those kind of contracts in addition, we start having a blended approach, which is it's an enterprise wide contract. So if you don't mind, let's get back to you on a future call.
Got it. And on indices, just want to get your thoughts on the growing trend of ETF issuers like BlackRock and Invesco deciding to go the self indexing route in the fixed income factor based arena. Is this something that concerns you?
Overall, the answer is no. That is a trend we don't think will be a large change to the market because if you look at the big benchmark indices, those are not really aimed to replace those. This is more for new categories of ETFs. So overall that's only for a very small part of the market. But there is not in our view any intention to compete with the large benchmark indices.
So overall we don't see that as a threat to our overall business model.
Thanks.
We will now take our final question from Alex Kramm from UBS. Your line is open.
Alex, welcome back. We get to follow-up on the first one.
Yes. Yes, I'm not sure what happened there, but thank you for coming. Actually, just quickly, on the rating side, since you asked about the cost earlier, maybe you can talk about the revenue opportunity there a little bit as well. I mean, anything new that you're investing in that you would point out? I know you've talked about China, but historically, you've lost some share in CMBS, for example.
What are you doing there? And then, Doug, I think you pointed out covered bonds being an area of strength. I thought you were actually pretty small in that business relative to your primary competitors. So are you catching up there? Anything you would point out where you're actually trying to grow the business organically on the rating side would be helpful.
Yes. Well, just to give you some examples and some ideas, as you know, our goal is to cover every asset class in every region in the world. And places where we don't have a position like in China domestic market, we're investing there. As you know, we had a weak run-in the CMBS market Over the last few years, we've invested there in our team, our criteria, our technology to be able to deliver. Last quarter, we were participating in 4 out of the 10 conduit fusion transactions in the CMBS market.
We are definitely making a concerted effort to continue to support the structured finance market. We're growing internationally in China. We're looking at more ways to grow in Southeast Asia. We have some products that we're working on in related to ESG, whether it's our green bond products and some other ESG indicators. So across the board, if you see any type of analytical product or ratings product, which is being developed, Whether we're developing and we have it ready to go, we definitely have somebody looking at it and we're working on it.
But the ones that are more promising is getting our way back into a much more, much larger position on structured finance globally, looking at China, looking at Southeast Asia, looking at ESG. These are some of those factors. I don't think I mentioned covered bonds. Covered bonds is an area that we do not have a strong position in. I maybe I misspoke or I was more likely talking about the high yield bond market in Europe, not necessarily covered bond market.
But anyway, we're excited about the growth in the ratings business and the opportunities we have there, especially with all of the new types of asset classes.
Thanks, Alex.
Great. Thank you.
Well, thank you, everyone, for the call. As you've seen today and as we presented on our Investor Day earlier in the quarter, S&P Global has developed a strategy to power the markets of the future. We've been incorporating the dynamics of the markets around us, looking at our competitors, understanding the competitive landscape, what's happening with technology. And as you can see from the quarter, we appreciate all the questions that you came back with. The leadership team here at the company is committed to deliver our performance both on a quarterly basis, but also in a way that we can allocate what I consider to
be our scarce capital
so that we can send it back to our shareholders, but also build and invest for the future of S and P Global. So I want to thank everyone for their support, for their participation on the call. The people in the Northern Hemisphere, I hope you also get a chance to enjoy the summer. So thank you very much, everyone.
That concludes this morning's call. A PDF version of the presenters' slides is available now for downloading from investor. Spglobal.com. A replay of this call, including the Q and A session, will be available in about 2 hours. The replay will be maintained on the S&P Global's website for 12 months from today and by telephone 1 month from today.
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