More writedowns loom for resilient Macquarie Group

The caveat that crawls like a corrosive worm through Macquarie Group's accounts is asset valuations - on Macquarie's co-investments in the family of funds it created and on the external debt and equity exposure the group holds.

But Macquarie is showing surprising resilience even as it books losses on its massive and complicated portfolio. When it ruled its books off for the September half it had excess capital, and very large cash resources: both are buffers as the crisis continues. Asset write-downs accounted for 80 per cent of Macquarie's provisioning charge of $1.14 billion in the September half, with de facto write-downs - on loss-making asset disposals, for example - accounting for the balance.

Even then, there was a subjective element. Macquarie did not mark stakes in its two biggest listed satellites, Macquarie Infrastructure Group and Macquarie Airports, to market value, arguing that the book value of the holdings is well below prices paid for airport and tollway assets in September and October.

Macquarie's chief executive, Nicholas Moore, produced a chart showing airport deals done at enterprise values of 18.9 times, 25.5 times and more than 28 times EBITDA - reported earnings before interest, tax, depreciation and amortisation - and deals on tollways pitched to generate modest internal rates of return of between 9.2 per cent and 11 per cent.

He compared that with Macquarie's valuations of just over 12 times EBITDA on its interests in Macquarie Airports and MIG to argue that write-downs are unnecessary. Moore says infrastructure asset values are holding up because properly structured infrastructure is still defensive: revenue will decline at airports and tollways as economic growth slows in the wake of the global financial crisis but airports and toll-roads continue to be virtual monopolies and should still generate better returns than competing investments including government bonds. MAP's Sydney Airport, for example, grew EBITDA by 9.4 per cent in the September quarter versus a year ago.

The risk is that the market will continue to drive asset prices lower, overwhelming academic valuation arguments. And more write-downs are coming for Macquarie, even if the market stays where it is, let alone gets worse. The group noted yesterday that if it were ruling off its books now instead of at September 30, there would be additional write-downs of $400 million.

The $3.40-a-share, 16.5 per cent, low trading-volume bounce in Macquarie's share price yesterday to $24 - which is still 75 per cent below its high of $97.10 in May last year - reflected the balance of considerations between the write-down risk inside Macquarie, and the September half's portrait of continuing financial strength.

Asset values are falling, and Macquarie is booking less revenue in virtually all of its major divisions. Those two elements combined to push net profit down 43 per cent in the half compared with the September half last year, and 19 per cent below earnings in the March half this year.

Macquarie says guidance is difficult because the markets are so chaotic, but that it expects its second half result to be similar the first it has just reported on.

But it has $5.9 billion of Tier One capital in place. That is equal to 11 per cent of risk-weighted assets, which compares to Tier One ratios of between 7.5 per cent and 8.2 per cent for the Big Four Australian trading banks.

Total capital is $10.3 billion, which is $3.26 billion, or 40 per cent above the regulatory minimum. Total assets of $167 billion are leveraged

16.3 times against the $10.3 billion capital base. The assets on the books of the Big Four Australian banks are leveraged 19.7 times on average. Macquarie says the assets of Barclays, HSBC, Royal Bank of Scotland and Standard Chartered in Britain are geared 24.6 times and the assets of Germany's Deutsche Bank and Dresdner Bank, Switzerland's UBS and Frances's SocGen are leveraged a very high 41.5 times, on average.

Reconfigured to conform with US GAAP accounting rules, Macquarie has assets of $135 billion and the same $10.3 billion capital wellspring, for gearing of 13.1 times. Bank of America, Citigroup, JPMorgan, Wachovia and Wells Fargo are geared 14.3 times on average, and the US investment banks, including Goldman Sachs, Merrill Lynch and Morgan Stanley, are leveraged 25.9 times. The group is reconfiguring and offloading assets and will bring gearing even lower, unless write-offs are enormous.

Before the September 30 interim rule-off date it sold $4 billion of assets, and after September 30 it sold a $2 billion Italian mortgage portfolio (and booked a $272 million loss), as part of a policy of quitting businesses that are over-reliant on securitised debt market funds and can no longer be financed as cheaply as the banks they compete with.

Another $9 billion of asset surgery is either being negotiated - the sale of the group's $2.9 billion margin lending book is one deal - or are sketched in, including the disposal of $2.3 billion of unspecified "low margin, funding intensive" assets.

Cash, meanwhile, is sitting at $26.3 billion, enough to totally pay out Maquarie's issued short-term debt of $18.9 billion and leave it funded 100 per cent by deposits at the short end.

Macquarie's excess capital - $3.26 billion at September and rising as asset sales go through - is, in effect, the group's cushion: the room it has to absorb write-downs, or to fund expansion.

Moore said yesterday the market crisis was at a point where expansion opportunities were presenting themselves. But for now Macquarie will stay focused on marshalling its resources, not deploying them.