Macquarie reshapes for a new era

Nicholas Moore will be praying that financial markets are at least relatively stable through the 2012-13 financial year. If they are, the year to March might well be seen as a watershed year in Macquarie Group's recent difficult history.

The 24 per cent fall in Macquarie's earnings for 2011-12 was broadly in line with the market's expectations given that, like most investment banks around the world, the profitability of Macquarie's market-facing businesses was inevitably savaged by the difficult market conditions and lack of client activity.

In fact those businesses – Macquarie Securities, Macquarie Capital, the fixed income, currencies and commodities (FICC) group and, to a degree, its banking and financial services business – experienced a combined $553 million reduction in their profitability over the year, with Macquarie Securities losing $194 million.

Moore would, however, have been happy with the performance of his ‘'annuity'' businesses, into which the group has been ploughing capital through the financial crisis. Macquarie's funds management business grew its earnings by $173 million and the corporate and asset finance business boosted its contribution by $124 million. The FICC experienced a significant turnaround in the second half, while banking and financial services held up quite well, with its earnings down only $10 million.

What is evident is that 2011-12 was the year Macquarie decided the sea-change in market conditions wasn't a temporary phenomenon and that it had to re-base its businesses.

Moore cut 1354 people and a net $419 million out of the group's cost base, but that understates the extent to which the group's cost structures have been lowered. With $227 million of investment in areas seen as having growth potential and $90 million of restructuring costs, the gross cost reductions totalled $736 million, or more than 13 per cent of its cost base.

Not surprisingly, the biggest cuts were within Macquarie Securities, Macquarie Capital, banking and financial services and the corporate centre. By the end of the 2012-13 year Macquarie expects the cost bases within Macquarie Securities and Macquarie Capital to be between 20 and 25 per cent lower than they were in 2010-11.

That leaves Macquarie better placed for any recovery, or indeed even stability, in financial markets – it would be leveraged to an improvement in trading volumes and client activity.

Its own outlook is for an improved result this financial year provided market conditions aren't worse than those experienced in 2011-12, with Macquarie Funds and Corporate and Asset Finance expected to produce earnings broadly in line with their latest results and all the other businesses expected to produce better performances.

If those conditions do materialise Macquarie will be slightly more leveraged to them, with plans (and regulatory approval) to buy back $500 million of its shares. That's less than the $800 million originally foreshadowed, although Macquarie did say that once the buy-back had been completed, and subject to further regulatory approval, it planned to continue the buy-back up to a total of 10 per cent of its ordinary shares.

Offshore, there has been a modest lift in investment banks' capital markets income despite continuing volatility, although like Macquarie the big investment banks are struggling to generate anything other than single-digit returns on equity. Macquarie's ROE was a meagre 6.8 per cent for the year, although it did improve to 7.8 per cent in the second half and the full impact of its cost reductions has yet to be seen.

The fundamental changes in the market environment and in the regulatory framework, which requires investment banks to hold more capital and liquidity and to eschew some forms of risk-taking, makes it unlikely the sector will be able to generate the kinds of returns it once did and certainly the shift in emphasis within the nature of Macquarie towards annuity-style income ought to see it producing lower but more stable and higher-quality returns than it did pre-crisis.

Given that the performance of its traditional investment banking activities are inextricably linked to the state of financial markets, to some extent their fate, other than the cost reductions, is beyond Macquarie's control.

Given some stability in markets, however, Macquarie may, having bitten the bullet and reshaped its cost base, have put the worst of its financial crisis experience – and it has been one of the better-performed of the international investment banks through the crisis, although that doesn't actually say much – behind it.

Moore, and the 14,200 staff he still has, will certainly hope so.