What a year it's been: Inflation is at its highest level in over 40 years, and the Federal Reserve is fighting it with aggressive rate increases from a near-zero level.
The Fed's actions had widespread ramifications. One area highly impacted is corporate lending. With rising interest rates, companies are less willing to take loans. Not only that, but investor appetite for risk dried up until we get a better idea of where interest rates will ultimately end up.
With corporate debt issuance down, rating agency Moody's (MCO -0.20%) is faced with one big question: Can its business weather this downturn?
Moody's is a crucial part of healthy financial markets
When companies raise money by issuing debt, investors weigh those risks and determine how likely a company can pay them off. This is where Moody's comes into play.
Moody's provides credit ratings for companies issuing debt across the globe and is essential to the fixed-income market. High barriers to entry make it hard for competition to enter the credit rating space, which is why Moody's and S&P Global dominate the industry, with about a 40% market share each.
Interest rates are wreaking havoc on its primary business
The credit rating business performed well over the last decade, as low interest rates encouraged companies to issue debt. This year has been a different story.
Persistent inflationary pressures have the Federal Reserve aggressively increasing interest rates to slow it down. These interest rate increases had ripple effects across financial markets. One area where you can see this show up is in credit markets.
According to the Securities Industry and Financial Markets Association (SIFMA), U.S. corporate bond issuance is down over 23% through August when compared to last year. High-yield debt issuance, or debt with a higher risk of default than investment grade, is down a whopping 75% from last year.
During Moody's second-quarter conference call, CEO Rob Fauber said, "Our ratings business were significantly impacted by the slowdown in issuance activity" and that "debt issuance markets are clearly in a period of cyclical turbulence." Through the first half of this year, Moody's revenue from its credit rating business was down 24%.
Moody's analytics business should pick up some of the slack
Moody's provides customers with analytics and insights around risk management and financial analysis through this business. The segment grew for 60 consecutive quarters and is expected to be more resilient in the face of an economic slowdown.
This year, Moody's saw strong demand for its insights as customers navigate uncertainty in the face of high inflation and rising interest rates. It saw good growth from its subscription and software-as-a-service (SaaS) business; this year, the segment's revenue grew 20%. This helped offset some of its rating business's decline, with Moody's total revenue down 8% compared to last year.
Moody's is optimistic about this segment for a good reason. For one, its analytic models are at the heart of pricing for property and casualty insurance companies, which look to avoid taking on policies with too much risk in regions where natural disasters could cause elevated losses.
Second, the segment recently signed a strategic partnership with one of the largest commercial real estate lenders to co-develop a lending solution -- helping Moody's tap into the $35 trillion global commercial real estate market.
Why Moody's can bounce back
Management believes the current credit issuance disruption is cyclical, meaning it's a passing phase, not something more permanent. "We believe that the fundamental drivers of issuance remain firmly intact," Fauber said, and "taking a medium-term view, we expect issuance to resume as capital markets adjust to a higher interest rate environment."
Moody's is a high-quality company with a competitive advantage in the credit rating space. This year is a bump in the road for that business, but it's a great sign that the analytics business is humming along -- making this an excellent company to buy on the dip in this bear market.