Credit rating agency Moody's (MCO 0.77%) saw business get a boost over the past two years, as low interest rates and favorable market conditions drove record levels of bond and debt issuance. As a result, its ratings activity boomed, and the stock outperformed in 2021, returning 34.5% versus the S&P 500's 27%.
However, Moody's may see headwinds in 2022. Investors have grown more concerned about inflationary pressures, and the Federal Reserve has discussed raising interest rates for the first time since the COVID-19 pandemic began. Here's what Moody's investors should watch for in 2022.
Market conditions have been favorable for ratings agencies
When companies issue debt, ratings agencies like Moody's bring transparency to these credit markets by giving debt issuances a rating score. These agencies grade bonds or other debt instruments that companies issue, determining how well those companies can meet their debt payment obligations.
Moody's has benefited from favorable market conditions that served as a tailwind for its business in 2020 and 2021. While the pandemic wreaked havoc on markets, the Federal Reserve's response of slashing interest rates and other easy monetary policies drove rapid debt issuance for companies.
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High debt issuance is great for ratings agencies like Moody's, which see increased demand for their services. In 2020, a record amount of corporate debt was issued -- with bond and loan issuance totaling $2.28 trillion. As a result, Moody's saw revenue increase 11% to $5.4 billion in 2020, while net income jumped 25% to nearly $1.8 billion.
These favorable conditions carried over into 2021, and Moody's saw the strongest third quarter ever for its ratings segment, with leveraged loan issuance holding firm. It also benefited from low default rates on debt and robust activity from private equity funds. Through the first nine months of 2021, Moody's saw revenue grow another 15% while net income increased 22%.
What investors should watch for in 2022
After enjoying strong growth over the last two years, Moody's CEO Robert Fauber said that "there are a little bit more headwinds than tailwinds going into 2022" during the company's third-quarter earnings call in October.
The company's credit rating business is directly affected by economic conditions and market volatility. It is dependent on the number and dollar volume of debt securities issued in capital markets. As a result, economic slowdowns hurt the agency. It may also see effects from increases in interest rates, which could impact future debt issuances.
Going forward, I expect growth from Moody's to slow as debt issuance moderates in 2022. According to Refinitiv, $1.86 trillion in investment-grade bonds were made in 2020, while another $1.46 trillion were made in 2021. However, analysts at Citigroup, Bank of America, and Deutsche Bank forecast a slowdown in 2022, with U.S. companies issuing between $1.3 trillion to $1.4 trillion in bonds during the year.
However, Fauber noted during the company's October earnings call that it does have some tailwinds for the business, including active debt issuance, continued strength in mergers and acquisitions, and a continued low-rate, low default environment. Moody's announces its full-year 2021 earnings on Feb. 11, and investors can expect to hear an updated view from management about what 2022 has in store.
