Hundreds of thousands factory

Investors in Macquarie Group might wish to avoid an article in The Economist, entitled “Can investment banks make high enough returns on equity to exist?” They may also consider it appropriate not to look to closely to Macquarie’s fundamentals. The gist of the argument is that investment banks will be “clobbered”  by the new Basel 3 rules. For most types of banking, the capital required will increase, and it will particularly hit investment-banking units because there will be a dramatic rise in the amount of risk-weighted-assets (RWAs) that it applies to.

The article says:

The result is that the absolute capital required under the new rules could be double that under the old ones. Taking the banks’ forecasts of their RWA under the new regime, and assuming a core capital ratio of 10%, the investment-banking units of Barclays and Credit Suisse made ROEs of about 10-11% last year, while JPMorgan’s division earned a slightly less paltry 13.5%.

It is at this point that investors might prefer to strategically look away from Macquarie’s fundamentals. According to Deutsche Bank (see report), Macquarie’s ROE is a paltry 8.7%, and the Basel changes have not been introduced. Even if Macquarie is not greatly affected by the new rules, it is not overly encouraging.

It is easy to be critical of Macquarie. Very easy. Especially after the bank was, in effect, part of the re-nationalisation of the Australian banking sector after the GFC.  Macquarie’s model of high fee specialist funds that clipped the ticket in every way possible then took a slice of the capital gains as well, was effectively destroyed by the GFC. It was a game for an era of high leverage and endless asset inflation, not the current environment.

Macquarie has become more like a traditional investment bank and funds management business, with all the attendant risks and operational difficulties, such as having to deal with markets that don’t continually go up.

Macquarie has been a global player, and Australia has too few of them (although just being global is not evidence -witness Centro). There is no doubt that Macquarie has a lot of talented, motivated, people. It will need them if it is to boost businesses such as its corporate asset finance enough to offset the decline in the more traditional securities, capital, fixed-income, currencies and commodities businesses.

Brokers are reasonably positive at these price levels. The stock has, of course, been hammered. Deutsche has a buy, and so does Southern Cross equities, which argues Macquarie has de-risked its business and “is ready to recapitalise on resurging global markets” (would that happen to occur).

It might also be said that the ROE figure is historical, so it is just that – the past. But the final sentence of The Economist article might send the odd shiver around the millionaire’s factory.

Come what may many firms will gradually come under more pressure from shareholders to do one of three things with their investment-banking units: exit, consolidate or slash employees’ pay.


MQG 8 February 2011

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  1. For those interested in the proposed RWA’s which will begin being implemented As of 1 January 2013.

    “The minimum common equity and Tier 1 requirements will be phased in between 1 January 2013 and 1 January 2015. On 1 January 2013, the minimum common equity requirement will rise from the current 2% level to 3.5%. The Tier 1 capital requirement will rise from 4% to 4.5%. On 1 January 2014, banks will have to meet a 4% minimum common equity requirement and a Tier 1 requirement of 5.5%. On 1 January 2015, banks will have to meet the 4.5% common equity and the 6% Tier 1 requirements. The total capital requirement remains at the existing level of 8.0% and so does not need to be phased in. The difference between the total capital requirement of 8.0% and the Tier 1 requirement can be met with Tier 2 and higher forms of capital. ”