A new model drives Macquarie's return to form

The expansion of Macquarie Group's funds management business has spearheaded its double-digit return on equity, while the outlook for its market-facing businesses continues to brighten.

While still a long way short of its glory days, the Macquarie Group has returned to double-digit returns of equity with its strongest and cleanest result since the financial crisis.

While the 11.1 per cent return on equity for the year wasn’t the first time Macquarie has reported a double-digit return since the crisis, the 2010 profit of $1 billion and return on equity of 10 per cent was inflated by the unwinding of the group’s listed satellite funds strategy and the near-$500 million of proceeds from the sales of their management rights.

In contrast, the 2014 result was built on more solid foundations. The three annuity-style businesses -- funds management, corporate and asset finance and banking and financial services -- lifted their contribution by 26 per cent, or $445m.

The expansion of those businesses, particularly funds management, where Macquarie now has $427bn of funds under management, is at the heart of the new Macquarie model. Pre-crisis, Macquarie’s funds under management were less than $200bn.

The three pared-down market-facing businesses that have struggled since 2009 -- Macquarie Securities, Macquarie Capital and the fixed income, currencies and commodities group -- lifted their contribution by 68 per cent, or $450m.

While carving into Macquarie’s cost bases, Nicholas Moore resisted the temptation (and the urgings of some in the market) to exit those businesses. Instead, he waited patiently for an improvement in market conditions to produce a rebound in their profitability.

While market conditions have improved, they aren’t buoyant. This provides some insight into how the market-facing businesses might perform in a stronger environment.

The result was slightly better than Macquarie foreshadowed in March and the market expected, but the cautious outlook appeared to disappoint the market.

What was striking about the result and the $1.27bn profit Macquarie produced was that the rate of increase in profit doubled between the first and second halves. The group’s return on equity in the second half was 13.5 per cent.

Moore, who tends to be quite conservative in his forecasting, expects that, markets willing, the results for 2014-15 will be broadly in line with today’s result. Given that the 2013-14 numbers include a $228m profit from the distribution of its Sydney Airport securities, that implies a material increase in earnings at an operational level.

If market conditions were to improve, however, there is a lot of leverage within the three market-facing businesses, which are still generating earnings about a third lower than their eight-year average.

The core of the post-crisis Macquarie is its funds management business, which added about $80bn of assets under management during the year. That helped drive a 28 per cent increase in its base fee income to $1.3bn and lifted its contribution to the profit above $1bn.

It would also have been the major factor in the Americas over-taking Australia as Macquarie’s major income-generating region for the first time. The Americas contributed 35 per cent of group income compared with Australia’s 32 per cent.

Macquarie’s international income now represents 68 per cent of its total income, underscoring the continuing internationalisation of the group.

With Moore continuing to look for acquisitions -- Macquarie still has about $2.7bn of surplus capital as well as a substantial investment portfolio it could sell down -- that trend will inevitably continue.

The market would be keen to see Macquarie continue to bulk up the funds management business. Earlier this year, Macquarie teamed with the giant private equity group Blackstone in a bid for JPMorgan’s commodities business, losing out to a $US3.5 billion bid by commodities trading group Mercuria.

Macquarie’s fixed interest, currencies and commodities business was the only one of the three markets-facing divisions to generate a profit ($700m) above its eight-year average, which might explain why Moore is keen on expanding it.

A number of the US banks are being forced out of their physical trading businesses by the post-crisis US regulatory environment, so other opportunities could arise in the sector. However, the bid for the JP Morgan unit signalled that Macquarie isn’t prepared to over-pay for assets.

Macquarie also announced that chairman Kevin McCann, who had been expected to retire this year, would now remain as chairman.

Macquarie appointed three new directors during the year. Appointing a new chairman as well might have been pushing the concept of board renewal a step too far.

Companies like to distance their changes of leadership, but whether or not McCann’s decision has any implication for further changes -- Moore has been chief executive for six years -- isn’t clear.

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