The global financial crisis was the trigger for the most prolonged period of value destruction in the 49-year history of Macquarie Group, as well as being the catalyst for a transformation that is still paying shareholders in spades.
A GFC-inspired share price plunge wiped $19 billion from the value of Macquarie between May 2007 and February 2009. This period of upheaval exposed a market-wide misunderstanding about how Macquarie worked.
The bank had talked for years about the strength of its core risk management function leading into the GFC. But it was clear from the savage market reaction that investors did not understand what this meant.
One person who capitalised on the lack of market knowledge about Macquarie was Jim Chanos, the founder of hedge fund Kynikos Associates in New York.
In May 2007, just when the first shockwaves of the GFC were working their way through capital markets, Chanos stood up at the high-profile Ira Sohn investor conference in New York and accused Macquarie of operating a Ponzi scheme.
He claimed Macquarie didn’t care what it paid for assets, it sold assets to the funds it managed at inflated values, and it used suspect valuation techniques.
These claims were repeated in an article in Fortune magazine by respected finance journalist Bethany McLean. It was McLean who published the definitive article blowing the whistle on US energy company Enron.
Enron was a genuine Ponzi scheme that actually made Chanos’ name among hedge funds. He called that early and made a huge killing.
His attack on Macquarie focused on the “Macquarie model” whereby Macquarie bankers were paid fees to advise on the purchase of assets that were bought by syndicates, including one or more Macquarie-managed funds which, in turn, paid fees to Macquarie. The third leg of the model was Macquarie bankers being paid fees to advise the Macquarie funds on their debt financing.
Chanos alleged that the model could not be sustained when interest rates rose. He had positioned his hedge fund to profit from a decline in the Macquarie share price by selling the stock short.
It is not known if Chanos held his short positions all the way through 2007 and 2008 and into early 2009. If so he would have done well. But with the benefit of hindsight he should have picked firms that went under, such as Bear Stearns or Lehman Bros.
Chanos was fundamentally wrong about the sustainability of Macquarie’s profits and its balance sheet resilience in the face of liquidity problems.
In hindsight, Macquarie’s balance sheet was stronger than other licensed Australian banks at the time simply because it was not borrowing short and lending long. It had matched all of its term liabilities with its assets. That is not to say it did not benefit from the government guarantee of wholesale funding, but in the lead-up to the Lehman collapse it ensured it could withstand liquidity difficulties in wholesale markets. In 2007 it had a policy that it should be able to meet all of its payment obligations for the next 12 months without accessing wholesale markets.
Macquarie chief executive Nicholas Moore, who will retire from Macquarie at the end of November, remembers well the first waves of the GFC hitting financial markets. He says this happened about two years before Lehman Bros went bust in September 2008.
“Macquarie as a financial institution has always been active in the capital markets on its own and on its clients’ behalf,” he says in an exclusive interview with Chanticleer.
“From 2006 we had thought liquidity was tightening and were not surprised to see liquidity really contract in 2007. This was evidenced by the failure of a number of European hedge funds in August 2007 and the surprising seizure in European money markets that same month, a further illustration of reducing liquidity and a further blow to confidence.
“We were more active than usual in the credit markets at that time as we were raising a term facility for our new Macquarie Group structure and so had a direct read on declining confidence. We completed our $9 billion term facility in November 2007.”
When Moore took over as CEO from Allan Moss in May 2008 he was not wedded to the old “Macquarie model”. He embarked upon the largest and most successful international expansion by any Australian-domiciled bank. Moore used the bank’s strong balance sheet to take advantage of opportunities created by the GFC. In March 2009 he bought Constellation and in August 2009 he bought Delaware.
Moore has overseen an increase in international income from 53 per cent in 2007 to 67 per cent in 2018. Of even greater significance for shareholders in the group is the increase in annuity-style businesses from 25 per cent to 70 per cent.
This radical transformation, which owes a lot to the work of incoming CEO Shemara Wikramanayake, has had two positive impacts for shareholders. The annuity-style businesses have delivered higher profit growth and a re-rating of the stock because investors are willing to pay more for funds management operations.
When asked how Macquarie got through the GFC, Moore emphasises the importance of its term financing.
“This is always very important to Macquarie as we seek to ensure all our term assets are funded by term liabilities, an opportunity which is not available to larger deposit-taking institutions which have a vital role in converting short-term deposits into longer-term assets such as mortgages and other term loans,” he says.
“From a financial system perspective, it is the central banks which provide the bridge between short-term deposits and longer-term assets by having the ability to ensure liquidity is available should a call be made. Their ability to provide this liquidity provides confidence in the system.”
Someone who worked closely with Moore during the crisis says he always remained cool under pressure.
“Nicholas was very calm,” the colleague says. “He made it clear if we needed to restructure or we needed to withdraw from some markets then we should do so.”
Moore opened the way for Macquarie to significantly cut its reliance on traditional investment banking revenue. It is now 14 per cent of earnings compared to 40 per cent when the GFC hit.
“During 2008 confidence continued to drain away from the system, leading to the Bear Sterns collapse and takeover by JP Morgan and which ultimately led to the collapse of Lehman Bros and the co-ordinated global steps to underwrite confidence in the finance sector in October 2008,” Moore says.
He is cautious in his comments about the lessons to be learnt, including issuing a veiled warning about Australia having the political will to stand behind banks when necessary. “Lessons from the crisis include the recognition that our shared sentiment, our hopes and fears probably overshoot on occasions,” he says. “Given the importance of finance to the broader economy we should ensure the system is as robust as possible, but recognise there will always be a vital need for control systems and government intervention.
“Since the crisis the system has become more robust, but we should never discount the need for intervention in a crisis.
“In Australia the system is more robust, and the powers of the regulator have been strengthened and we believe there exists the political and regulatory will to act should this be required. Plainly it would be a tragedy if the necessary powers were not used in a crisis.”
Moore has overseen a total shareholder return of 274 per cent. Under his leadership, Macquarie’s market capitalisation has risen by about $32 billion, far more than the damage caused during the GFC. Best of all he has left plenty in the Macquarie tank for his successor.