Credit Opinion: Macquarie Group Limited

Transcription

1 Credit Opinion: Macquarie Group Limited Global Credit Research - 09 Nov 2014 Sydney, New South Wales, Australia Ratings Category Moody's Rating Outlook Stable Issuer Rating A3 Senior Unsecured A3 Subordinate MTN (P)Baa3 ST Issuer Rating P-2 Other Short Term (P)P-2 Macquarie Financial Holdings Limited Outlook Stable Issuer Rating ST Issuer Rating A3 P-2 Macquarie Bank Limited Outlook Stable Bank Deposits Bank Financial Strength A2/P-1 C- Baseline Credit Assessment Adjusted Baseline Credit Assessment baa1 baa1 Issuer Rating Senior Unsecured A2 A2 Subordinate Baa2 Commercial Paper Other Short Term P-1 (P)P-1 Contacts Analyst Phone Ilya Serov/Sydney Francesco Mirenzi/Sydney Stephen Long/Hong Kong Tanya Tang/Sydney Key Indicators Macquarie Group Limited (Consolidated Financials)[1] [2]3-14 [2]3-13 [2]3-12 [2]3-11 [3]3-10 Avg. Total Assets (AUD million) , ,795.0 [4] Total Assets (USD million) , ,818.3 [4] Tangible Common Equity (AUD million) , ,846.5 [4] Tangible Common Equity (USD million) , ,037.6 [4] Net Interest Margin (%) [5]1.1 (Market Funds - Liquid Assets) / Total Assets (%) [5]10.7 Core Deposits / Average Gross Loans (%) [5]73.9 Tier 1 Ratio (%) [6]10.6 Cost / Income Ratio (%) [5]75.5 Problem Loans / Gross Loans (%) [5]1.4 Problem Loans / (Equity + Loan Loss Reserves) (%) [5]5.2 Source: Moody's

2 [1] All figures and ratios are adjusted using Moody's standard adjustments [2] Basel III - transitional phase-in; IFRS [3] Basel II; IFRS [4] Compound Annual Growth Rate based on IFRS reporting periods [5] IFRS reporting periods have been used for average calculation [6] Basel III - transitional phase-in & IFRS reporting periods have been used for average calculation Opinion SUMMARY RATING RATIONALE The A3 / P-2 ratings of Macquarie Group Limited (MGL) reflect its strong overall credit profile. The A3 rating also includes two notches of uplift to reflect our view that depositors and senior bondholders would benefit from systemic support, if needed. Our rating view of MGL's standalone credit profile balances the risks of the group's continual evolution, and its earnings profile -- which is subject to a degree of volatility -- against the credit positives of the group's strong capitalization and liquidity metrics, its entrenched market position in Australia and management's prioritization of business lines with greater earnings stability. In particular we note: - MGL's shock-absorbing capacity has been strengthening. This reflects the rising contribution of its more stable earnings sources -- such as Macquarie Funds Group, asset finance and its traditional banking businesses -- which offset the inherent volatility of its capital market-facing operations. In addition, MGL's risk appetite in its capital markets businesses appears contained with trading revenues weighted to commodities business -- which has historically been less volatile at MGL -- and conservative market risk management. - MGL's balance sheet is a strength, but is also an area of ongoing rating focus. The firm has historically maintained a cautious approach to its liquidity policy. Its liquidity resources are in excess of two times the level of wholesale term debt maturities coming due over the following 12 months. It has also run significant surpluses to minimum capital requirements, although these declined through 2014 and 1H 2015, partly as a result of the inspecie distribution of MGL's stake in Sydney Airport, and reflecting increasing capital needs to support growth. Indeed, rapid growth of longer-dated and/or funding-intensive products could, if unchecked, stretch its balance sheet. The trend towards smaller capital cushions over minimum regulatory requirements, if continued, would be detrimental to the firm's maneuverability. As a result, how MGL chooses to deploy its balance sheet, as its business model evolves, is a key credit consideration. - A high probability that MGL would receive systemic support in case of need, as a consequence of its significant presence in Australia's financial markets and its close operational links with its main banking subsidiary Macquarie Bank Limited (MBL). We continue to view the regulatory and political framework in Australia to be favorable to the interests of senior bank creditors, in contrast to many developed markets affected by the global financial crisis. As a result, we incorporate two notches of systemic support uplift into the ratings of MBL, and, by extension, MGL. (Please select "Read Full Report" for a more in-depth discussion. Note that the Pre-Provision Income / Average RWA and Net income/ Average RWA ratios in the Key Indicators Table are calculated under the Basel III regime as of FY In Australia, minimum capital requirements under Basel III have been met since 1 January 2013 and there are no transitional arrangements for capital deductions. To calculate the average risk weighted assets for FY 2013, only reporting period subsequent to 1 January 2013 were used). Rating Drivers - An increasingly diversified business profile - Conservative risk management is key to MGL's credit profile - Capital levels remain supportive; future positioning is a key credit consideration - Liquidity is at the upper end of the peer group - Strong potential for systemic support. Rating Outlook

3 The outlook is stable for all the ratings of MGL and its subsidiaries. What Could Change the Rating - Up Despite its more diversified ratings profile, MGL retains exposure to financial market conditions. As a result even if operating conditions improve markedly, the prospect of an upgrade is unlikely. The standalone ratings of Baa1 on Macquarie's operating units, MBL and Macquarie Financial Holdings Limited (MFHL), position the firm at the higher end of the range applicable to wholesale banks. What Could Change the Rating - Down The ratings would come under negative pressure should the trend towards a more diversified business profile reverse itself and result in a higher exposure to volatile financial markets businesses. Any signs of a loss of discipline in its risk management or a material reduction in its capital and liquidity buffers would also be detrimental to its ratings. As the ratings of MGL, MBL and MFHL incorporate the potential for systemic support, any signal from the regulator or government that suggests a less creditor-friendly stance on bank resolution could create downward pressure on the supported ratings DETAILED RATING CONSIDERATIONS AN INCREASINGLY DIVERSIFIED BUSINSS PROFILE MGL's earnings are highly diversified by product and geography. MGL's activities are carried out through six primary business lines: Macquarie Securities (securities brokerage and trading), Macquarie Capital (investment banking / advisory), FICC, Banking and Financial Services (retail banking and wealth management), Corporate and Asset Finance (corporate lending and leasing), and Macquarie Funds Group (funds management). In the past few years, MGL has made significant progress in diversifying its business profile and reducing its reliance on business lines sensitive to financial market conditions. This has resulted in an enhanced ability to absorb any earnings shocks arising from market volatility. The group has pursued both organic growth opportunities -- most recently in its traditional banking area -- as well as growth through acquisitions, in funds management, leasing, and certain parts of its commodities business. Overall, net profits from non-capital market operations -- comprised of retail banking and wealth management, corporate lending and leasing, and funds management -- have been increasing steadily since 2009, providing the firm with a core, reliable source of earnings that serve to offset its more volatile capital markets-related earnings. Underlying these trends have been: - An overall reduction in the proportion of capital markets-derived earnings. Since 2009, the group's advisory and underwriting revenues have fallen from around 40% of overall revenues to approximately 16% today. Trading revenues have remained stable at around 19% of total revenues, leaving aside an unusually high result in the March 2014 half, and which was in part driven by commodities trading gains during an unusually severe North American winter. While, to some extent, the drop in the proportion of capital markets revenues is a reflection of the subdued operating conditions prevailing during this period, MGL also took initiatives to reduce its longer-run footprint in the institutional derivatives segment during 2011 and its headcount in the Macquarie Securities and Macquarie Capital lines of business (in aggregate, a reduction of 45% since September 2009). - Growing importance of Macquarie Funds Group. The firm's funds management operations are now its biggest earnings contributor, accounting for approximately 30% of its pre-tax profits (excluding its Corporate Centre). Its assets under management grew from AUD 189 billion in September 2009 to AUD 423 billion in September Correspondingly, the base fees derived by Macquarie Funds Group have grown from AUD 315 million to AUD 641 million. In addition, MGL has generated an increasing stream of performance fees, with a jump from AUD 55 million to AUD 373 million between September 2013 and September 2014, reflecting asset realizations and outperformance relative to benchmarks within Macquarie Infrastructure Company and Macquarie European Infrastructure Fund 1. We expect performance fees to constitute a material factor during 2015 as its closed-end funds launched in 2004 and 2005 mature and underlying assets begin to get realized. - The firm has been expanding its domestic residential lending, asset finance and motor vehicle leasing. Its leasing book grew from AUD2.8 billion in 2009 to AUD 12.4 billion in September 2014, assisted by a number of acquisitions (notably those of Ford Credit and GMAC's Australian motor vehicle lease portfolios in 2009 and 2010) as well as organic growth. More recently, it has been rapidly growing its domestic mortgage book, with a

4 annualized growth rate of 71%. MGL frequently seeks to exploit high-return opportunities that may be sub-scale for the largest global banks. MGL's business structure is decentralised, enabling the firm to respond swiftly to market opportunities. The firm's ability to react nimbly to changing market conditions has served it well in the past, while its diversified profile helps earnings stability and reduces the risk of large sudden losses arising from correlated exposures. CONSERVATIVE RISK MANAGEMENT IS KEY TO MGL'S CREDIT PROFILE The benefits of MGL's global scope and diversification come at the cost of complexity of its operating platform and elevated risk management challenges. In addition, despite the gradual shift in focus to more stable earnings sources discussed above, MGL continues to exhibit a strong reliance on capital markets businesses, which still account for 24% of its earnings. We consider MGL's ability to maintain a conservative risk culture as being one of the firm's most difficult tasks. The large number of MGL's business units and geographies has the potential to stretch management attention and requires tight risk controls, cognizant of market, regulatory and reputational pressures both on an individual unit and on a portfolio basis. To date, management has been focused on containing its markets exposure through a combination of tight risk management oversight and an emphasis on less volatile streams of trading revenue. Positively, we note MGL's well-embedded risk culture, as well as the discipline displayed by the firm with regard recent acquisition bids where MGL was ultimately an unsuccessful under-bidder. While the firm's track record and ability to limit earnings volatility so far are encouraging, the challenge is considerable, particularly as the group grows larger, or pursues further growth opportunities through acquisitions. CAPITAL LEVELS REMAIN SUPPORTIVE; FUTURE POSITIONING IS A KEY CREDIT CONSIDERATION The firm's capital requirements are a combination of Basel III capital requirements for its banking operations contained within MBL and additional capital requirements in respect of its non-banking operations calculated on the basis of an economic capital adequacy model (reviewed by the Australian Prudential Regulation Authority). MGL's capital deployment has been focused on the group's three divisions with relatively more stable cash flows (its `annuities-style' businesses --Macquarie Funds, Banking and Financial Services, and Corporate and Asset Finance), which have seen an additional AUD 0.4 billion capital deployed during 1H 2015, bringing their overall capital requirements to $6.2 billion or 53% of total capital requirements for the group. This is the highest proportion of capital allocated to these businesses over the recent past. Partly as a consequence of higher capital needs, the group has reported a reduced APRA Basel III Common Equity Tier 1 (CET 1) ratio of 8.7% (down from 9.6% as at FY 2014). On a self-reported `raw' Basel III basis, the CET 1 ratio was 10.8% (down from 11.4% as at FY 2014). The capital requirements in respect of MGL's non-bank entities are just under AUD 3 billion, relative to total nonbank funded assets of AUD 13.2 billion. The group has increased the `equivalent risk weight' (i.e. the amount of capital held against funded assets, excluding net trading assets and deposits held with MBL, assuming the standard 8% capital requirement) to in excess of 200%. Against its equity investments and co-investments in Macquarie-managed funds, it reports a 49% capital-to-assets ratio. In total, as at September 2014, MGL had AUD 1.4 billion of capital buffers relative to APRA's requirements, assuming a minimum CET 1 ratio of 8.5% of the group's risk-weighted assets. This continues the trend toward a reduced capital buffer, which has decreased from 27% as at March 2013 to 16% in 1H However, including the recent hybrid issuance, the capital surplus is AUD 1.8 billion. Although at this point we view the reduction in the capital buffer as credit-neutral, a continuation of the longer-term trend towards lower capital surpluses could put Macquarie's credit profile under pressure. In this respect, we see the issuance of an AUD 429 million hybrid instrument on October 2014, the reduced dividend payout ratio of 62% and the re-introduction of a discount on the group's dividend reinvestment plan, all of which help buttress its capital ratio, as indicative of management's commitment to maintain a conservative balance sheet, which is a key support to Macquarie's credit profile. LIQUIDITY IS AT THE UPPER END OF THE PEER GROUP On a consolidated level, MGL's liquidity metrics are at the upper end of its peer group. The group has considerably increased its liquidity resources since the global financial crisis to over two times the level of wholesale term debt

5 maturities coming due over the following 12 months. MGL's standard liquidity policy is to ensure that at least twelve months' maturities can be met from internal sources. The high level of MGL's operational integration with its principal operating subsidiaries is apparent from an analysis of its liquidity and funding profile. The legal entity MGL does not itself carry any liquid assets, despite being a legal entity undertaking some borrowing for the broader group. Liquid asset coverage of MGL's debt is effectively maintained at the operating subsidiary level. MGL's operating subsidiaries are currently very liquid. The group's external wholesale funding is chiefly raised by MBL. MBL has also successfully grown its deposit base on the back of its private client business. Deposit growth was further boosted by clients switching cash balances from the group's Cash Management Trust to deposits. Factors we would view to support the stickiness of such deposits are the fact that they are transaction accounts with relatively small average balances, such that there would be a high degree of coverage by Australia's Financial Claims Scheme (a form of deposit insurance). In 1H 2015, the group has seen the proportion of short-term funding increase to 12% (and 14% for the bank entity). This is well below the pre-crisis levels but compares unfavorably with the level of 6% reported in 2012 and We note that in 1H 2015 Macquarie increased its holdings of liquid assets, somewhat mitigating these concerns. Our expectation is that short-term funding will stabilize at around 10-12% of the group's overall funding needs. Moody's views management's commitment to maintaining strong liquidity coverage as major positive factor underpinning the group's ratings, but will continue to monitor the group's funding profile as its business model evolves. STRONG POTENTIAL FOR SYSTEMIC SUPPORT We believe the probability that MGL would benefit from systemic support in case of need to be high. In contrast to many crisis-hit economies, we view the regulatory and political framework in Australia to continue to be favorable to bank creditor interests. We also note that, to date, the regulatory focus in Australia has been heavily on the preservation of systemic stability and that the Macquarie group as a whole has a significant presence in Australia's financial markets. Within the group, we believe that the chief beneficiary of support would likely be MBL, and accordingly we incorporate two notches of systemic support in its A2 rating. We note that during the global financial crisis in , only MBL was eligible under the government's guarantee programme for debt and large deposits. Nevertheless, considering the high degree of operational and financial integration between MGL and its operating subsidiaries, we view their credit profiles to be closely linked. In particular, whereas there is a global regulatory trend towards "pre-positioning", such as requiring separate, or easily separable, IT systems for different legal entities; the Australian regulator has shown little appetite to date to require "pre-positioning" for bank resolution. We view this to reduce the probability that, in a crisis, the Macquarie group could swiftly be unbundled and, consequently, we believe it increases the probability that the group would be supported as a whole. Australia is a member of the Financial Stability Board (FSB), and in its interim report, Australia's Financial System Inquiry has highlighted the lack of statutory bail-in as a gap relative to international standards. The Australian authorities have thus far adopted a cautious and nuanced public stance on creditor bail-in. Treasury has commented that further consideration is warranted, but noted concerns about the workability of bail-in for large institutions. At the same time, while supporting the FSB's aims to minimize the burden of bank resolution costs on tax payers, the RBA has opined that the policy "toolkit" should retain the ability to "take an institution under public ownership before selling it again when the risk appetite of the private sector has returned to more normal levels". MGL'S RELATIONSHIP TO THE RATINGS OF ITS OPERATING SUBSIDIARIES MGL's A3 rating is positioned one notch below the A2 rating of MBL. MBL dominates the group both in terms of assets and earnings. MGL's rating is positioned in line with Moody's usual notching practice for holding companies, which recognizes the structural subordination of MGL's creditors to those of its principal operating subsidiary. We assign the following ratings to MGL's principal operating subsidiaries: - Macquarie Bank Limited is rated C- for bank financial strength, which equates to a stand-alone rating of baa1. The bank's A2 / P-1 for deposit and debt ratings incorporate two notches of uplift for potential systemic support. - Macquarie Financial Holdings Limited is the operating holding company for non-bank's entities. We regard MFHL's intrinsic credit profile to be closely aligned to the baa1 stand-alone rating of the bank, because the

6 operations of the two are closely interlinked: three of the group's six business lines cross over the boundaries between MBL and MFHL. MFHL's issuer rating incorporates uplift for systemic support as a result of its close integration with the bank. This publication does not announce a credit rating action. For any credit ratings referenced in this publication, please see the ratings tab on the issuer/entity page on for the most updated credit rating action information and rating history Moody's Corporation, Moody's Investors Service, Inc., Moody's Analytics, Inc. and/or their licensors and affiliates (collectively, "MOODY'S"). All rights reserved. CREDIT RATINGS ISSUED BY MOODY'S INVESTORS SERVICE, INC. ("MIS") AND ITS AFFILIATES ARE MOODY'S CURRENT OPINIONS OF THE RELATIVE FUTURE CREDIT RISK OF ENTITIES, CREDIT COMMITMENTS, OR DEBT OR DEBT-LIKE SECURITIES, AND CREDIT RATINGS AND RESEARCH PUBLICATIONS PUBLISHED BY MOODY'S ("MOODY'S PUBLICATION") MAY INCLUDE MOODY'S CURRENT OPINIONS OF THE RELATIVE FUTURE CREDIT RISK OF ENTITIES, CREDIT COMMITMENTS, OR DEBT OR DEBT-LIKE SECURITIES. MOODY'S DEFINES CREDIT RISK AS THE RISK THAT AN ENTITY MAY NOT MEET ITS CONTRACTUAL, FINANCIAL OBLIGATIONS AS THEY COME DUE AND ANY ESTIMATED FINANCIAL LOSS IN THE EVENT OF DEFAULT. CREDIT RATINGS DO NOT ADDRESS ANY OTHER RISK, INCLUDING BUT NOT LIMITED TO: LIQUIDITY RISK, MARKET VALUE RISK, OR PRICE VOLATILITY. CREDIT RATINGS AND MOODY'S OPINIONS INCLUDED IN MOODY'S PUBLICATIONS ARE NOT STATEMENTS OF CURRENT OR HISTORICAL FACT. MOODY'S PUBLICATIONS MAY ALSO INCLUDE QUANTITATIVE MODEL-BASED ESTIMATES OF CREDIT RISK AND RELATED OPINIONS OR COMMENTARY PUBLISHED BY MOODY'S ANALYTICS, INC. CREDIT RATINGS AND MOODY'S PUBLICATIONS DO NOT CONSTITUTE OR PROVIDE INVESTMENT OR FINANCIAL ADVICE, AND CREDIT RATINGS AND MOODY'S PUBLICATIONS ARE NOT AND DO NOT PROVIDE RECOMMENDATIONS TO PURCHASE, SELL, OR HOLD PARTICULAR SECURITIES. NEITHER CREDIT RATINGS NOR MOODY'S PUBLICATIONS COMMENT ON THE SUITABILITY OF AN INVESTMENT FOR ANY PARTICULAR INVESTOR. MOODY'S ISSUES ITS CREDIT RATINGS AND PUBLISHES MOODY'S PUBLICATIONS WITH THE EXPECTATION AND UNDERSTANDING THAT EACH INVESTOR WILL, WITH DUE CARE, MAKE ITS OWN STUDY AND EVALUATION OF EACH SECURITY THAT IS UNDER CONSIDERATION FOR PURCHASE, HOLDING, OR SALE. MOODY'S CREDIT RATINGS AND MOODY'S PUBLICATIONS ARE NOT INTENDED FOR USE BY RETAIL INVESTORS AND IT WOULD BE RECKLESS FOR RETAIL INVESTORS TO CONSIDER MOODY'S CREDIT RATINGS OR MOODY'S PUBLICATIONS IN MAKING ANY INVESTMENT DECISION. IF IN DOUBT YOU SHOULD CONTACT YOUR FINANCIAL OR OTHER PROFESSIONAL ADVISER. ALL INFORMATION CONTAINED HEREIN IS PROTECTED BY LAW, INCLUDING BUT NOT LIMITED TO, COPYRIGHT LAW, AND NONE OF SUCH INFORMATION MAY BE COPIED OR OTHERWISE

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