The new president of the U.S. Donald Trump has been making more promises overnight to reportedly slash regulations by 75% or "maybe more" for businesses operating in North America.
President Trump has also scrapped U.S. participation in the Trans Pacific Partnership (TPP) free trade deal and is intent on renegotiating the North American Free Trade (NAFTA) deal in a move that is likely to damage Mexican prosperity far more than any proposals for a border wall.
Any move to deregulate and lessen compliance burdens will also benefit a banking sector that has been weighed down since the GFC by the multiple new laws introduced to protect consumers, reduce banks' leverage and improve their risk management practices.
Until President Trump's arrival it was commonly accepted wisdom amongst government policymakers, financial regulators, and central bankers that the reason for the world's economic crash in 2009 was the wild overleverage of the financial system and banks in particular.
In fact ex-Bank of England Governor Mervyn King is on record as stating that some major banks were leveraged by ratios of 40 to 1 prior to the GFC, which is the equivalent of running your finances by buying a $1 million house with just a $25,000 deposit.
Consequently many regulations were introduced after the GFC in part to force banks to hold more capital in reserve versus the amount of money they lend as assets on their balance sheet. The result of all this new regulation via the Basel Reforms, Dodd Frank Wall Street Reform and Consumer Protection Acts in the U.S. were significant new compliance, middle and back office monitoring costs for banks and their trading arms.
If 75% of regulations in the U.S. were abolished and corporate tax rates slashed from 35% to "between 15% to 20%" then investment banks like Macquarie Group Ltd (ASX: MQG) are likely to find their profitability soaring where they have significant U.S. operations.
Macquarie is well known for its adaptability and shifting tax rate as the geographic mix of its earnings conveniently changes. For example for the financial year ending March 2016 the group's tax rate fell to 30.6% from 35.6% a year earlier, as the group shifts its tax liabilities across different geographies.
You can bet your bottom dollar that the bonus-loving bankers will be rubbing their hands with glee at the prospect of taking advantage of President Trump's move to slash corporate tax rates and reduce compliance costs with around one third of the group's earnings already coming from North America.
The bank is a big fish in a small investment-banking pond in Australia which gives it certain competitive advantages in winning work, but in the U.S. it's a small fish in a ferociously competitive pond dominated by the powerful U.S. investment banks.
That's why Macquarie tends to focus on specialist areas in the U.S. such as infrastructure asset management, asset financing and the specialist buying of distressed debt.
In particular it specialises in privately investing in infrastructure projects and managing infrastructure debt funds on behalf of institutional clients. Other significant fee streams in the space include work around structuring, collateralizing, monitoring, issuing and underwriting debt on behalf of private or public clients.
If inflation returns and debt yields in general rise under a Trump administration then the kind of debt Macquarie buys to match insurers or pension funds' long-dated liabilities in the U.S. is likely to provide better returns for its clients and higher fees for the bank. Moreover, it's possible that more work could come its way if construction billionaire Trump holds good to his promise to invest up to a $1 trillion in new infrastructure projects in the U.S.
Insurers like QBE Insurance Group Ltd (ASX: QBE), or others seeking to match off liabilities like Computershare Ltd (ASX: CPU) are the kind of businesses that may also benefit from rising yields on money market and longer dated debt.
Outlook
This morning Macquarie Group shares are up 1% to $84.43 which looks reasonable value on 13x trailing earnings, with a yield of 4.8%. Given its continued shift into the asset management space, U.S. tailwinds and well-known ability to adapt quickly I expect it will continue to outperform the market and its Australian banking sector peers like Australia & New Zealand Banking Group (ASX: ANZ) over the years ahead.
