How stability is paying off for the new Macquarie

In May, when Nicholas Moore announced Macquarie Group’s best result since the financial crisis, there was an underlying tone of confidence to his presentation. That confidence remains, despite Moore telling today’s annual meeting that results for the first quarter of this financial year were down on both the same quarter last year and the immediately preceding quarter.

Despite the slow start, however, Moore re-stated the guidance he provided with the full-year results. He said the group continued to expect that the combined net profit contribution from its operating divisions will be up on last financial year’s, even though a lower contribution is expected from Macquarie Securities and Macquarie won’t have the $228 million profit it booked from last year’s distribution of its Sydney Airports securities.

The soft start to the financial year is attributable to two of its markets-facing businesses, Macquarie Securities and its Fixed Income, Currencies and Commodities (FICC) businesses.

That’s not surprising. It has been widely remarked on that the current environment is one of ultra-low volatility. Markets-related businesses make more money when markets are volatile and investors and traders risk-averse. Moore also said the capital markets businesses were affected by the timing of transactions, an impact that presumably will flow into stronger results as the year progresses.

The only change to the group’s May outlook statement for its operating groups was to the outlook for Macquarie Securities. In May, the outlook was for an improvement on its 2013-14 contribution of $107 million, whereas today that was changed to an expectation that its earnings would be lower.

A key factor in the undertone of confidence in Moore’s view of Macquarie’s near term prospects is that the group has, barring some new global crisis, more upside than downside.

In the year since the financial crisis, Macquarie has heavily tilted its portfolio away from its exposures to markets, albeit not entirely, and towards more stable annuity income from its funds management and banking and financial services businesses.

Macquarie Securities, Macquarie Capital in particular, and the FICC businesses to a lesser extent, have been heavily restructured and downsized to the point where they are far less central to the group and where their further downside is limited.

Should markets become more volatile and/or there are more transactions (Macquarie Capital is benefitting from increased global mergers and acquisitions activity) those businesses ought to be leveraged to the increased volumes of activity. In the meantime, if they more or less hold their own the annuity-style businesses ought to be able to pull the group’s underlying earnings forward.

The asymmetrical nature of the relationship between downside risk and upside opportunities in the restructured markets-facing businesses may underpin Moore’s confidence that, barring something unforeseen, Macquarie will be able to match last year’s performance without the benefit of the Sydney Airports transaction and may even better it if market conditions improve.

While the 2013-14 result wasn’t Macquarie’s first double-digit return on equity since the crisis, it was its strongest and cleanest result -- and Moore believes it can deliver "superior" performance over the medium term.

What’s not generally well-recognised is that, relative to its peers – other international investment banks – Macquarie has already delivered superior performance, with a 10-year return on equity of 16.2 per cent compared with the industry average of 9.5 per cent and a widening gap of out-performance in the post-crisis period.

The crisis stress-tested the group and forced changes to its structure and strategies that have created a quite different and somewhat less frenetic and aggressive ‘’Macquarie Model’’ to the pre-crisis version, with more stable and higher-quality income flows.

If markets were, at worst, to remain relatively stable, the 2013-14 financial year might well come to be seen as the year in which Macquarie finally completed its response to the crisis and the basic changes to its model and 2014-15 as the year when a clearer and cleaner picture of the new Macquarie emerges.