Macquarie highlights difficult quarter

Macquarie offloads a $1.07 billion margin lending portfolio realising $30 million in profit, but its shares lose 3.7% on a warning that profits have been adversely impacted by market conditions.
The Macquarie Group announced yesterday the sale of a A$1.5 billion ($1.07 billion) margin lending portfolio to Bendigo and Adelaide Bank for A$52 million and noted that difficult markets had adversely impacted quarterly profits. The latter part of the statement caused its shares to lose around 4%.

Macquarie announced in September 2008 that it was exploring the sale of its investment lending business as a follow-on to an earlier decision to wind back its mortgage business, both driven by the increased cost of funding due to changed market conditions. It said, at the time, that investment lending contributes less than one percent of Macquarie Group profits.

The sales are part of an effort to reduce funded assets on Macquarie's balance sheet by A$15 billion and allow the Australian financial services firm to focus on the more profitable parts of its business. Around A$12 billion of such initiatives have now been completed and the reduction of the remaining A$3 billion is underway and expected to be completed by March 31.

The latest sale was made to Leveraged Equities, a wholly-owned subsidiary of Bendigo and Adelaide Bank Limited. Macquarie will be paid in the form of A$52 million of short-dated convertible preference shares issued by Bendigo and Adelaide Bank. The preference shares will convert in three tranches of A$20 million, A$20 million and A$12 million after 30, 60 and 90 days respectively.

The sale of the portfolio will contribute A$43 million to MacquarieÆs profits, which was factored into the interim results declared earlier.

Bendigo is Australia's third largest player in margin lending with a portfolio of A$2.1 billion and a 12% market share. This transaction will see it acquire the fourth largest û Macquarie's market share is estimated at around 11% û and will significantly consolidate its position in this business. Bendigo said it expects the acquisition to be earnings accretive in the first year.

Macquarie Private Wealth, the group's retail stockbroking division, will sign a three-year distribution agreement with Leveraged Equities so that Macquarie can continue to provide margin loan products to its clients. The agreement also provides for the possibility of an extension beyond the initial three years.

Macquarie also announced that in the most recent quarter, ended December 31, it has been able to increase its retail deposits by 27% to A$11.9 billion, increase term funding by 14% to A$36.5 billion and issue $3.3 billion of government guaranteed funding, including a $2.1 billion five-year 144A placement.

However, despite all the positive news, investors were spooked by MacquarieÆs outlook statement issued along with the news of the margin lending portfolio divestment. Macquarie reiterated that short-term forecasting was made difficult by ôa number of significant swing factors notably market conditions, asset realisations, completion rate of transactions and asset pricesö and cautioned that profits of the past quarter were impacted by market conditions.

Macquarie's share price fell 3.7% to close the day at A$32.50, having recovered from an intra-day low of A$31.19. Bendigo lost 3% to A$10.55 as investors were not convinced this is the time to acquire a margin lending business. The overall Australian market was also weak, losing 2.3%.

MacquarieÆs next operational briefing is scheduled for February and analysts suggest that yesterdayÆs statement is setting the tone for the firm to change its earlier guidance. Macquarie declared a profit of A$1.8 billion for the financial year ended March 31, 2008, up 23% on the previous year, the 16th consecutive year of record profits from the firm.

While it may not be able to repeat last yearÆs success, Macquarie has thus far weathered the crisis without having to shore up capital. Its success in shrinking its balance sheet is further evidenced by the ability to offload its margin lending portfolio even in the difficult market conditions prevailing since the Lehman Brothers bankruptcy.

Investment banks around the world have been affected by more difficult capital markets, leverage drying up and lesser deal flow. But pure investment banks may not be the right comparables for Macquarie, as highlighted by J.P. Morgan in its most recent research update on the Australian bank. The US firm suggests that a comparison of Macquarie with global investment banks is incorrect because ôMacquarieÆs historic earnings profile has been far less volatile than global investment banks, it carries lower exposures to principal trading activities than global investment banks, and its revenue recognition is more conservative than global investment banksö.

Sunil Garg, head of Asia (ex-Japan) research for J.P. Morgan and a banking sector expert, said yesterday that MacquarieÆs outlook statement can be deemed a profit warning, especially in light of the last statement in the Macquarie release: ôduring the quarter to December 31 market conditions were exceptionally challenging for almost all Macquarie's businesses, adversely impacting levels of business activity and profitabilityö.
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