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Moody’s Corporation (NYSE:MCO)

Q3 2010 Earnings Call

October 28, 2010; 11:30 am ET

Executives

Ray McDaniel - Chairman & Chief Executive Officer

Linda Huber - Chief Financial Officer

Liz Zale - Vice President of Investor Relations

Analysts

Peter Appert – Piper Jaffray

Michael Meltz – JPMorgan

Craig Huber – Access 342

Brian Shipman – Jefferies

Edward Atorino – Benchmark

Sloan Bohlen - Goldman Sachs

Bill Clark - Keefe, Bruyette & Woods

Operator

Good day and welcome, ladies and gentlemen, to the Moody's Corporation’s Third Quarter 2010 Earnings Conference Call. At this time, I would like to inform you that this conference is being recorded and then all participants are in listen-only mode.

As a 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 Ms. Liz Zale, Vice President of Investor Relations. Please go ahead.

Liz Zale

Thank you. Good morning, everyone and thanks for joining us on this teleconference to discuss Moody's results for the third quarter of 2010. I am Liz Zale, Vice President of Investor Relations.

Moody's released its results this morning for the third quarter of 2010. The earnings’ press release and a presentation to accompany this teleconference are both available on our website at ir.moodys.com. Ray McDaniel, Chairman and Chief Executive Officer of Moody's Corporation will lead this morning's conference call. Also making prepared remarks on the call is Linda Huber, Chief Financial Officer of Moody's Corporation.

Before we begin, I call your attention to the Safe Harbor language, which can be found toward the end of our earnings release. Today's remarks may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.

In accordance with the act, I also direct your attention to the management's discussion and analysis section and the risk factors discussed in our annual report on Form 10-K for the year ended December 31st, 2009, our Form 10-Q for the period ended June 30th, 2010, 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 statements 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 Ray McDaniel.

Ray McDaniel

Thank you, Liz. Good morning and thanks to everyone for joining in today's call. I'll begin our remarks by summarizing Moody’s third quarter and year-to-date 2010 results. Linda will follow with additional financial detail and operating highlights. I'll then speak to recent developments in the legislative and regulatory area and finish with comments on Moody's business initiatives and outlook for 2010.

After our prepared remarks we'd be happy to respond to your questions. Moody’s results for the third quarter reflecting strong performance at Moody’s Investor Service associated with robust capital market issuances as well as, steady growth for Moody’s Analytics.

Total revenue was $513 million up 14% from the third quarter of 2009. Operating income for the third quarter was $189 million an increase of 10% year-over-year. Diluted earnings per share for the quarter of $0.58 included a one-time tax benefit of $0.07 associated with foreign earnings. Excluding minor restructuring related adjustments in both years, diluted EPS for the quarter of $0.58 grew by 35% year-over-year.

Turning to year-to-date performance, revenue for the first nine months of 2010 totaled $1.45 billion, a 12% increase over the same period in 2009. Expenses were $892 million, up 11% from the prior year period, and operating income of $576 million increased 13%.

Revenue at Moody’s Investors Service for the first nine months of 2010 was $1 billion, an increase of 15% from the prior year period. Moody’s Analytics revenue is $445 million, 5% higher than the prior year period.

Based on year-to-date performance and our expectations for the remainder of the year, we are raising our full-year 2010 EPS guidance to a range of $1.90 to $1.96, from the prior range of $1.75 to $1.85.

I will now turn the call over to Linda to provide further commentary on our results and other updates.

Linda Huber

Thanks, Ray. Good morning everyone. I’ll begin with revenue at the corporate level. As Ray mentioned, Moody’s total revenue for the quarter was up 14% year-over-year. For the third quarter, US revenue increased 21% to $278 million, while revenue outside the US increased 6% to $235 million, representing 46% of Moody’s total revenue. Recurring revenue of $283 million represented 55% of total revenue compared to 62% in the prior year period.

Looking now at each of our businesses, starting with Moody’s Investors Service, revenue for the quarter was $358 million, a 17% increase year-over-year. US revenue was up 26% over the prior year period. Outside the US revenue grew 7% and represented 42% of total ratings revenue.

Global corporate finance revenue in the third quarter increased 43% from a year ago to $145 million. Revenue grew 51% in the US, primarily driven by strong, high yield bank loan and bond origination for refinancing and increased merger and acquisition activity. Outside the US, revenue increased 29% from the prior-year period with strong high yield bond issuance in Europe and improved activity in Asia and Latin America.

Global structured finance revenue for the third quarter was $70 million, 11% below the prior year period. In US, revenue declined 8% year-over-year with much derivative activities partially offset by improved commercial real estate finance issuance. Non-US structured finance revenue was down 15% with reduced European derivatives and securitization activity. Decline was partially offset by growth in covered bond activity.

Global financial institutions revenue of $74 million increased 17% from the third quarter of 2009 primarily due to higher levels of insurance sector issuance in the US and greater activity in the banking sector internationally. US financial institutions revenue grew 14% well as part of the US revenue was up 19%. Global revenue for public project and infrastructure finance grew by 13% year-over-year to $70 million.

Revenue increased 24% in the US with higher volumes in the public finance and infrastructure sectors. Non-US revenue declined 7% primarily due to lower issuance volume in European infrastructure finance. Turning now to Moody’s Analytics, global revenue from Moody’s Analytics of $155 million was up 6% from the third quarter of 2009. US revenue grew by 10% year-over-year to $71 million.

Non-US revenue increased by 3% to $84 million and represented 54% of total analytics revenue. Growth was primarily lead by the delivery of risk management software projects and improving demand for research and data.

Globally, revenue from research data in analytics of $106 million increased by 3% from the prior year period and represented about 68% of total MA revenue. The return to growth for this business reflects further stabilization among our capital markets customers as financial industry conditions improve. Revenue from risk management software of $43 million grew 16% while revenue from professional services of $6 million was flat with the prior year period.

Growth rates in both of these business units are subject to significant quarter-to-quarter volatility due to the variable nature of project timing and the concentration of revenue in a relatively small number of engagements.

Turning now to expenses, Moody’s third quarter expenses were $324 million an increase of 16% compared to the third quarter of 2009. The increase was primarily due to greater headcount, our approvals for incentive compensation reflecting the stronger full year outlook, as well as additional spending relating to legal matters and regulatory requirements.

Excluding, restructuring related items from both periods, third quarter 2010 expenses increased 18%. Moody’s operating margin for the third quarter of 2010 was 36.8% compared to 38.2% in the third quarter of 2009. Our expected tax rate for the quarter was 24.4% compared with 37.5% for the prior year period. The difference was primarily due to a one-time tax benefit associated to foreign earnings.

Now, I’ll provide an update on capital allocation and stock buybacks. During the third quarter of 2010, Moody’s repurchase of 0.8 million shares at a total cost of $20 million. As of September 30th, 2010, Moody’s has $1.3 billion of share repurchase process authorization certainly remaining under its kind of program.

Through much of the third quarter share repurchase activity was curtailed due to media awareness of non-public information relating to wealth matters that we received in the spring, which was closed without any enforcement action against the company. Moody’s also issued $0.8 million shares under employee stock-based compensations plans. Outstanding shares as of September 30th, 2010 totaled $234 million representing a 1% decline from a year earlier.

During the quarter, Moody’s completed a public offering of $500 million of ten-year senior unsecured notes at a coupon 5.5%. Proceeds are expected to be used for general corporate purposes, including repayments of outstanding commercial paper and other short-term and long-term borrowings, working capital, capital expenditures, possible acquisitions and other business investments and share buybacks.

At quarter end, Moody’s had $1.3 billion of outstanding debt and possibly $985 million of additional debt capacity available under its revolving credit facility. Cash and cash equivalents were $794 million, a $371 million increase from the prior year period.

We remain committed to using our strong cash flow to create value for shareholders while maintaining sufficient liquidity. For the reminder of 2010, we expect to continue to show repurchase at modest levels subject to available cash flow, market conditions and other ongoing capital allocation decisions.

And with that I’ll turn the call back over to Ray.

Ray McDaniel

Thanks Linda. I’ll continue now with an update on legislative and regulatory developments, in US its part of the initial rule making process following the passage of the Dodd-Frank Act. On September 29th, the SEC amended regulation service closure or Reg FD to remove the specific exemption for credit rating agencies.

We are now addressing the confidentiality of information used in the ratings process by revising our agreements with issuers as appropriate. With respect to the majority of other provisions relevant to nationally recognized credit rating agencies and with Dodd-Frank Act. The SEC has provided a schedule of implementation activities over the coming months that include establishing new office credit ratings in October and naming a Director to that office in November.

And proposing rules between January and March of 2011 on various matters such as important of internal controls, transparency of ratings performance and references to credit ratings and statues regulations and rules adoption of the proposed sets of rules is planned for April to July 2011. By the new rules, will have various changes in our process in operations did not alter our fundamental business objectives to broad the highest quality credit opinions research and analysis.

In January, we also expect the SEC to provide guidance on the recession of rule 436-G and it’s interaction with regulation 8-D, which has been interpretive to acquire ratings to be included in the prospects of problem free offered securitizations.

In Europe, as far our application become a registered credit rating agency under the new EU regulatory region. And they are continuing interaction with European authorities to address the registration process and other considerations including the transfer of rating agency over site to a newly established European Securities and Markets Authority. We also expect the EU Commission to, the European Commission to the release a consultation paper in the near future regarding matters such as rating agency competition and business models and the regulatory use of ratings.

At a global level, international monitory fund and the financial stability board have recently published papers addressing the use of ratings and regulation. Both the IMS and the FSP advocate reducing reliance on ratings as mechanical triggers, which result in automatic responses. We agree with this position and we offered our public support through comments on regulatory proposals.

As regulatory reviews and activity occur in other jurisdictions and we will continue to advocate for globally consistent approaches inline with the G20 statements and the efforts. I’ll conclude today’s prepared remarks by reviewing a few business initiatives in the quarter and commenting on our full year guidance.

I’m pleased to report that during the third quarter Moody’s Analytics established the Institute of Risk Standards and Qualifications, which was launched the first risk management accreditation program for bank professionals based on a core consistent standard. We’ve developed the program’s competency requirements with the help of a broad base of industry practitioners and academics.

With the goal of capturing reference from the recent crisis and promoting a higher level of financial risk management proficiency among banking practitioners. We also launched Moody’s Small Business Information Zone or moodysbiz.com an online resource that provides small business analysts with free access to economic data and planning tools to help manage their businesses. There is also been a market leader in providing analysis and data to financial professionals and this side leverages our experience in resources to serve the small business community as well as municipalities and universities.

These outlook for 2010 is based on assumptions about many macroeconomic and capital market factors, including interest rates, corporate profitability and business investment spending, merge and acquisition activity, consumer borrowing and securitization and eventual, to our government sponsored economic stabilization initiatives. There is an important degree of uncertainty surrounding these assumptions and if actual conditions differ, Moody’s results for the year may differ materially from our credit forecast.

As mentioned earlier we’re increasing our full year 2010 EPS guidance to the range of $1.90 to a $1.96. And certain components of 2010 guidance, have been modified to reflect our current view of credit market conditions and implications for the company.

My comments highlight those components that have been revised and we refer you to our earnings release for a full view of our guidance. Our full year outlook issues foreign currency translation at exchange rate as of the end of the third quarter. In Moody’s Corporation we now expect revenue to grow in the high single-digit to low double-digit percent range. And expenses to increase in the low double-digit percent range.

As previously discussed, we expect operating expenses to increase throughout the year and normal seasonal pattern that is magnified by plans and committed spending including our hiring activities. We continue to estimate incremental costs related to new regulation would be approximately $15 million for this year and $15 million to $25 million for next year.

The company still projects the full-year 2010 operating margin in the high-30% range we now expects the 2010 effective tax rate to be in the range of 33% to 34%. At Moody’s Investor Services, we now expect global revenue growth in the low double-digit percent range. In the US, we expect MIS revenue to increase in the high teens percent range while non-US revenues expected to get in the low to mid single-digit percent range.

Corporate finance revenue is now projected to increase from the low 30% range. Structured finance revenue is expected to decline in the mid single-digit percent range, while revenues from financial institutions were expected to grow in the mid single-digit percent range.

The Moody’s Analytics, our outlook for both risk management software and professional services now reflects revenue growth in the mid teens percent range. That concludes our prepared remarks and joining us for the question-and-answer section are Michel Madelain, our Chief Operating Officer of Moody's Investors Service; and Mark Almeida, the President of Moody's Analytics.

We will be pleased to take any questions you may have.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) We’ll take our first question from Peter Appert with Piper Jaffray.

Peter Appert – Piper Jaffray

Thanks. Question for Linda, can you help me understand a little better the dynamics, which behind the cost growth in the third quarter and specifically, Linda, I don’t know if you can call out what portion of the cost might be one-time in the quarter in terms of catch up accruals or compliance implementation et cetera?

Linda Huber

Sure Peter, let me start with the big picture here for the third quarter of last year our total expenses were $290 million and for the third quarter of this year as we have said we are at about $339 million for the up-tick it’s about $50 million. I would like to explain this as about $25 million of this would be considered catch up and potentially one off and about $20 million of this is run rate.

Above $30 million of this is a combination of incentive compensation, because that is the revised guidance and we performed better than we’ve expected and profit sharing. So just going with the first part in incentive compensation we’ve spoke about $75 million so far for the year for incentive compensation, so you can think about it above $25 million a quarter.

We also said about a $3 million to be submit for profit sharing, we also then had higher cost as we said in professional services, which includes IT regulatory and legal of about $11.5 million. So we would hope that we don’t have to see that again and of course, the incentive compensation true up would also be one-time. So to be approximately, $50 million increase about half of this is one-time. Now on the run rate, it’s important to understand that we’ve got something here that are going to continue on.

Primarily, we have increase headcount by about 7% and we’ve also have mere increases and we’ve had higher Moody’s Analytics commissions. All of which are good because many of this increase is regarding revenue. All of those changes are about $20 million for the third quarter year-over-year. So Peter, I hope that explains the expense increase in the two components you’re looking for.

Peter Appert – Piper Jaffray

Excellent, very helpful, thank you. And then just a follow up on that one just the 7% increase in headcount, I know you signaled that you’re adding staff, but I just can’t quite get my hands one why is the staffing needs to increase so much in the context of revenue run rate numbers, it is still well below where you are a few years ago?

Linda Huber

Right, I think the important thing to note here Peter is that many of these people are going to Moody’s Analytics as we have said and a number of the people are going to lower cost stuff areas as we look to make sure that the analysts have a reasonable work load under the new regulatory regime. So it would be those things, should also be noted that a number of these divisions are outside the US I opposed to within the US. So some of them are in fact at lower cost, but we are doing exactly what we said, we would do over the course of the year.

Raymond McDaniel

Just a little more color on that, Peter. The hiring that is going on, on the Moody’s Analytics side has been both for our software development activities outside the US, but also importantly for sales. And we have talked in some of our previous calls about the fact that the customer base for Moody’s Analytics has been shifting somewhat from the very large institutions that we have always served to small and more regional institutions, which requires more selling capacity to be able to get to those institutions so that’s part of the hiring on that side.

And as Linda noted, there continues to be hiring for the full range of internal controls compliance legal technology audit associated with moving Moody’s Investor Service into a more fully regulated environment. It just requires changes to work processes documentation reporting that require incremental resource.

Peter Appert – Piper Jaffray

Understand. And Ray, one another thing and I’ll get off, I noticed that the revenue growth rate for Moody’s Investor Services at 17% is quite a bit higher than what S&P reported yesterday and I understand part of that is just a function of pricing models, but it also looks to the higher when thinking what Fitch is doing. So can you just comment on what you’re seeing from a market share standpoint as it relates to this superior revenue performance?

Ray McDaniel

I do seeing that part of this is a mix of transaction versus recurring revenue I cannot speak to any awareness of material changes in market share. We have had strong addition of new issuers who have been seeking ratings this year both inside the US and outside the US that’s associated with increased capital market activity particularly what capital market and bank loan activity, which are tend to be smaller issuers would not as frequently be in the bond markets or in the related loan market. So we have had a good year in terms of increasing the number of new rating relationships I don’t have a comparison on that with our competitors.

Peter Appert – Piper Jaffray

Okay, great. Thanks Ray and Linda.

Operator

Out next question is Michael Meltz with JPMorgan.

Michael Meltz – JPMorgan

I’d like to thank Appert for the market share question. Two questions for you, the margin drive for or I guess lack of margin drive, I understand the costs in the investments you’re making and some of which are run rate and some are one-off. Taking a step back as you look over the next few years, I think we’ve talked about before 40% to 45% is where the business could or perhaps should be longer-term. Do you still feel that way? And then I have a follow-up.

Linda Huber

Okay. Let me take a shot at this Michael and then I’ll let Ray comment further. If you look at our operating income is $188.9 million and you add that to $13 million and extraordinary incentive compensation and profit sharing, which I explained it gets about $202 million of operating income, which takes your margin to a little over 39% and as I said we’ve had an overage in professional services at about $11.5 million of that you get to something like $213 million or margin back over 41%.

So we could see that that this can be reached, but given what we’ve given just right now to build into this regulatory requirements as we’ve said we’re going to ramp expenses throughout the year and we haven’t reached the full run rate yet on those so hope that illustrates that we can get there, but unfortunately not quite yet for this quarter.

Ray McDaniel

I want to offer a note of caution also in terms of the fact that the regulatory process is - well is well it is much clearer than it has been earlier this year or certainly last year, still has quite a bit of activity going into 2011 that we are going to have to be in a position to address.

As I’ve mentioned in the prepared remarks, SEC rule making in many areas hasn’t even become visible. I mean I am sure the SEC is working on it, but they have not made proposed rules public in areas that are going to affect us, we will see that in the first and second quarters of next year, because a lot of the rule making had a 12 month window after passage of Dodd-Frank.

We also have the European consultation, which we expect to have released shortly, and we have banking system regulators that are looking at the use of ratings and regulations in particular and so we are assuming there are going to be increased costs and resource needs associated with some or all of this, but we don’t have a great deal of clarity yet on exactly what that maybe and as the rules and proposals are released we’ll be able to talk to you about this more intelligently.

Michael Meltz – JP Morgan

Has your view on margin structure changed since the Investor Day?

Ray McDaniel

My view on margin structure has not changed, but we have the – if we are thinking about the increasing cost associated in particular with the Moody’s Investor Service and the internal control and reporting environment, I think what is fair to say is that, it has been extended beyond what I would have expected back on Investor Day. So there is more going on and it is going on further out in time than I would have forecasted six to nine months ago.

Michael Meltz – JP Morgan

Okay, one follow-up. Linda, I am coming out, because I am sure will ask the subscription or these transaction recurring, but within structured finance do you still have a good slug of recurring revenues in there or surveillance revenues, how should we be thinking about the phasing of those revenues over the next three plus years, is there an expectation of a cliff or just modest fade or how should, how will that play out?

Linda Huber

Sure, you are right, we’ll probably get to the details here on transaction versus relationship, for the third quarter for structured just that you have the top line Michael transaction was 47%, relationship was 53%. I think the your second theory there on the slow decline is the correct one, and we will see somewhat of a decline as the stock of those structured revenue comes down.

However, in terms of total recurring revenues, we have had obviously a massive influxes corporate ratings, which needs to be monitored and so we will have additional recurring monitoring fees that go with those new corporate ratings. So overall we will see a net increase in our total recurring revenues, but you are right that structure will have a small ramp down.

Michael Meltz – JP Morgan

Alright, thank you.

Operator

Our next question is Craig Huber with Access 342.

Craig Huber – Access 342

Good afternoon, I just thought I’d be next. Just I was trying to ask you Linda, can you breakdown first if you would the transaction versus non-transaction percentages between structured, corporate, financial et cetera?

Linda Huber

Well sure. As I was just saying to Michael for Q3 Craig, the ratings first with transaction and then with relationship it’s 47 versus 53 for structured but corporate we play on a very strong issue this quarter 74% transaction, 26% relationship.

Financial institution 37% transaction and 63% relationship and public project and infrastructure finance 60% transaction and 40% relationship. So for the rating agency as a whole 58% transaction, 42% relationship, from Moody’s Analytics we are running 14% transaction and 86% relationship, so for the corporation as a whole 45% transaction and 55% relationship.

Craig Huber – Access 342

Okay, then also another housekeeping question, within each of those structured corporate et cetera, can you breakdown if would the percentages that have come from high yield bank loans investment grade and also with the three main category still?

Lind Huber

Yes. Hang on just a second when we get that. Sure, for the third quarter investment grade issuance was 21% of global corporate finance revenue, that was growth was 26% of total corporate finance revenue, bank loans 15% and other, which as you know includes monitoring mid in term notes short commercial paper and so on was 37%.

Craig Huber – Access 342

And if you could do the same thing for finance institutions PPIF structured if you would?

Linda Huber

Sure, financial institutions the banking revenue was 70% of total FIG revenue for Q3, insurance was 25% and management investments was 5%, and then going on to PPIF, PFG and Sarbanes were 30%, the structured finance was 8% and project and infrastructure was 42%.

And I think we get structure let me see if we can find that for you Craig. For structured for Q3 33%, after tax 12%, R&D at mortgages, covered bonds 11%, commercial real estate 17% and derivatives 27%.

Craig Huber – Access 342

Okay, then also a point of clarification in a new guidance, EPS guidance of $1.90 to $1.96 does that or does that not include the $0.07 tax benefit you talk about for this quarter, you just finished.

Linda Huber

Yeah, as in fact Mr. Appert has noted in his writings this morning, it does include that $0.07 tax benefit.

Craig Huber - Access 342

It does include the $0.07.

Linda Huber

Yes, affirmative.

Craig Huber - Access 342

But excludes all these other smaller one-time items throughout the year?

Raymond McDaniel

It’s a GAAP guidance number, the guidance range.

Craig Huber - Access 342

Okay, I think I am done, thank you very much.

Raymond McDaniel

Thank you.

Linda Huber

Welcome.

Operator

Next question is Brian Shipman with Jefferies.

Brian Shipman – Jefferies

Thanks, good morning. Just a question on hiring again with respect to the compliance related to hiring specifically, when did you begin hiring that staffing so aggressively. And is the compliance related hiring completed at this point or do you say or what the remaining regulatory issues that you just mentioned Ray? Is that going to require that you continue ramping this staffing level up further?

Raymond McDaniel

I believe we are going to have to continue to ramp it up further, how much we have to do so, will depend on the actual SEC and then European Union rules that we’re operating under next year and 2012. We have been hiring in the compliance area I would say on a reasonably steady basis.

We didn’t try to concentrate hiring in any one quarter. Although with the passage of Dodd-Frank there has been more clarity around, but some of our obligations and responsibilities are going to be, and so we have been active in the hiring in the third quarter.

Linda Huber

Brian its Linda its probably worth noting that, roughly 300 people that we’ve hired two-thirds of those are within analytics and rating agency and less than a third are within the staff, of those in the staffs, I don’t want you to have the wrong impression, the compliance team would be a small portion of that, but certainly not the majority, a lot of these hires are in middle office, IT and other support functions, so I just want to make sure you don’t come away with that thinking we’re hiring hundreds of people in compliance, because we are not.

Raymond McDaniel

No, I think it’s also important to understand that when we talk about complying with a new regulatory environment, some of that compliance is our people who are working in the lines of business and the operating Moody’s Investor Service business where work processes and work flows and documentation have changed. So it wouldn’t all be in a staff function even if some of it relates to regulatory changes.

Brian Shipman – Jefferies

It’s very helpful, thank you.

Operator

Next question is Edward Atorino from Benchmark.

Edward Atorino – Benchmark

Interest expense and other line, has just run that out at sort of a good run rate?

Linda Huber

Sure, let me talk a little bit about that. The total non-op expenses for the third quarter, let’s start with interest expense. One thing I might want to note that interest on our borrowings have gone up, because we have got our new $500 million bond deal in there with a 5.5% coupon on it.

So you want to think about total interest expense, it’s about $13 million. Now it is better on FX line and we have got some income from our JVs offsetting that. So, in the third quarter you want to call it an expensive $8 million to $9 million and we got that as an exhibit to earnings release. You can take a look at that.

Edward Atorino – Benchmark

Yeah. It’s right down there. I got.

Linda Huber

Right there.

Edward Atorino – Benchmark

Okay, didn’t look at the bottom of the page. Thanks.

Linda Huber

Sure, trying to be helpful.

Edward Atorino – Benchmark

Very helpful, as always.

Operator

Next question is Sloan Bohlen with Goldman Sachs.

Sloan Bohlen - Goldman Sachs

Hi, there, not to try to beat a dead horse, but just on the topic of kind of how big of a moving target the expenses are either for regulatory or other going forward. Can you maybe drill down about, which area there could be the most variability there? Is it on the compliance side? Or is it on rotation of analyst teams and where along that timeline for next year do you think you’ll have a better chance?

Linda Huber

I can take a quick shot. For the rest of this year, as we said we expect expenses to go up throughout the course of this year. So for this quarter, we’re looking at $324 million as total expense offsetting our royalty elimination. So we would expect that to go up a bit further for the fourth quarter, particularly as I said these run rate changes that’s we hired some new people. So that would be the one area. I will let Ray comment a little bit more on the longer-term.

Ray McDaniel

Yeah, I think we have done a good job this year in forecasting what our incremental cost would be associated with the compliance. The numbers that we were talking about early in the year are numbers that are still holding today. We have the preliminary estimate of $15 million to $25 million incremental expense next year associated with regulation that is not all in compliance. Again it is spread across lines of business, the internal control functions technology.

So that we are able to be incompliance with various things. But, at this point, I don’t have any reason to move off of that number. But I would feel, I will feel much more confident about that once we see proposed SEC rules early next year and understand better what the EU consultation expectations will be.

Sloan Bohlen - Goldman Sachs

Okay, switching gears maybe to a bigger picture question just on, kind of the conflicts on interests in the business and further discussion I guess headlines referred from either people at the SEC or people live here in Europe. Are those comments being made as part of official review processes or has there been a back and forth? Or can you give us a sense of, I guess where they are along kind of their review of that conflict?

Raymond McDaniel

Well, the SEC has been asked to conduct a study over the next two years with respect to conflicts of interest and the business model. It’s something that has been raised by European authorities, as well as, as an area they want to look into. And we have been in a dialogue with I think all of the relevant authorities about business models and the proper way to manage conflicts of interest.

Then those of you on the call who heard that we speak about this before have heard me observed that there are indeed potential conflicts of interest in this business as there would be in any business in which we are paid by parties that care about the outcome of our opinions and analysis.

So, whether that is issuers or investors or governments that are paying us, there are conflicts that must be managed. That is offset by the public good of our ratings and that they can be distributed for free to the investing public under our current business model, whereas they would not be able to be distributed for free to the investing public if we had to move to a subscription service or some other kind of a selective dissemination service.

So, I think that turns the question to being able to demonstrate that we are properly managing the potential conflicts we face. I think we are going to be able to do that to the satisfaction of all regulatory authorities. And that’s why I am sure, we’ll be part of our responsibilities and obligations going forward, because they are going to be inspecting us and looking at that.

Sloan Bohlen - Goldman Sachs

Okay. But it’s fair to say we are still in the very early stages of those discussions.

Raymond McDaniel

Yes, those discussions have been going on for a long time and I imagine it will continue to go on for a long time.

Sloan Bohlen - Goldman Sachs

Okay, fair enough. Thank you guys.

Operator

Our next question is Bill Clark with Keefe, Bruyette & Woods

Bill Clark - Keefe, Bruyette & Woods

Thanks for taking my question. Just on the structured finance revenues, did you see any impact from the six month suspension of the need for ratings this quarter? I think it was the first quarter you had a fall kind of impact from that. I am just wondering if there was anything significant that you saw from that.

Raymond McDaniel

Given the interim solution that the SEC put in place, we really didn’t see any material impact, I don’t think. If the SEC had not acted, I think it’s more likely that we would have seen a material impact, because of the changes that would have that the rules would have had on the ability to issue a certain classes of securities, at least public securities.

So that the changes that have gone on, that have occurred in the last six months with respect to Rule 17g-5, affecting structured finance issuance, and the 436(g), which was again put into this interim holding pattern.

I think that we have seen market participants having to make changes to how they are planning to bring securities to market in the structured finance area, how they interact with rating agencies to some extent and also questioning what the final solution with respect to 436(g) will be and the impact that that would have in 2011. But I don’t think it has had a material impact for 2010.

Bill Clark - Keefe, Bruyette & Woods

Okay, great. Thank you.

Operator

Next question is a follow-up from Peter Appert with Piper Jaffray.

Peter Appert – Piper Jaffray

Ray, sorry for the double-dip here. But on the litigation front, it looks like you had a pretty important win the other day. Ray, so number one, I was just hoping you comment on how you see the relative significance of that particular decision and then number two maybe a little update on where things stand generally from litigation standpoint? Thanks.

Raymond McDaniel

Sure, there was a ruling earlier this week by a Judge in California, which granted our motion to dismiss with prejudice, claims from a plaintiff of intentional and negligent misrepresentation this is called the rights case. And we obviously were pleased that the motion to dismiss was granted and we think that the Judge correctly applied the law. It is a federal court, not a state court and so, for example with respect to the CalPERS litigation, I think the Judge’s decision not may very well prove to be helpful, but it is in federal court not the state court.

With respect to the litigation more broadly, there is not anything material to report at this point. In total, we’ve had, I think it’s 17 cases dismissed, ratings related cases dismissed since the beginning of the financial crisis and we certainly expect that number to continue to rise. But I don’t have anything else to report at this point.

Peter Appert – Piper Jaffray

But, because it was a federal decision Ray, and I think most of these fraud cases aren’t filed in federal court, do you view this has been a fairly significant precedent from that perspective?

Ray McDaniel

Well, again it’s I think helpful and the Judge’s reasoning I think is something that we would cite. But other Judges in other districts are going to make their own decisions.

Peter Appert – Piper Jaffray

Okay, thank you.

Operator

Next question is Craig Huber with Access 342.

Craig Huber -- Access 342

Yes, it’s a follow-up question. Would you not mind ball parking for us how much you think your incremental legal cost would be this year. Do you think it will be roughly $25 million this year or nowhere near that?

Ray McDaniel

I understand the curiosity Craig. I don’t think we’re going to disclose what we think our legal costs are going to be.

Craig Huber -- Access 342

Okay, then also just if you could clarify with us further Linda your incentive accruals for the quarter. What were they and what were they a year ago please? I think the first two quarters this year your incentive compensation accruals I think $21 million in the first quarter, I think $17 million, $18 million in the second. What was in the third please?

Linda Huber

They are good Craig. For the first quarter of 2010, it was 20.8 instead of compensation. In the second quarter it was 18.3, and for the third quarter it’s 35.5. So, we review that as about a $10.5 million catch up on the incentive accrual, because obviously the company has performed above our forecast and we’ve raised guidance. A little chunk of the previous $13 million number I have mentioned is profit sharing, which also given the kind of year we’re having looks likes it’s likely to kick in.

Compare that to last year the pattern was different, Q1 of last year was about $9 million, Q2 was $14.5 million, and Q3 was $25 million. So this year we’re running at about $75 million all in, which is healthy increase to where we were last year. So, as I said for this year $75 million so far, averaging $25 million a quarter. So you might want to think about that for the fourth quarter.

Craig Huber -- Access 342

I mean, if I heard you right Linda, is it striking your total – operating cost during the fourth quarter to be up slightly from this third quarter total?

Linda Huber

Yes

Craig Huber -- Access 342

That’s true? Okay. Great, thank you.

Operator

Our next question is Michael Meltz with JPMorgan.

Michael Meltz – JP Morgan

Just one final one from me, we’ve gone through all these questions, nobody has asked about the business in the fourth quarter and your guidance, your listing guidance for revenues. Can you just talk a little bit about what are you, any real changes especially on corporate issuance, which was so strong in Q3?

Ray McDaniel

Well, we don’t expect revenue in the fourth quarter to be as high as it was in the third quarter. We have had a pretty good October in terms of corporate issuance including high yield and bank loans. But the strength of the third quarter, particularly September, I think is going to be hard to duplicate.

Michael Meltz – JP Morgan

Great. Thanks Ray.

Operator

We have no further questions in queue.

Ray McDaniel

Okay, thank you very much for joining us and we look forward to speaking with you again after the first of the year. Thank you.

Operator

This concludes Moody’s third quarter earnings call. As a reminder, a replay of this call will be available after 4:00 p.m. Eastern Time on Moody’s website. Thank you.

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