Writing in international finance news site BreakingViews, Edward Chancellor and Lauren Silva have prepared an extensive, but less than flattering, analysis of the Macquarie Bank business model. A risky business, they conclude:

Risks are increasing for infrastructure investors. Rising competition among specialist funds, from Goldman Sachs and others, has pushed up prices. Easy conditions in the credit markets have encouraged infrastructure investors to take on ever larger amounts of debt. That makes for a toxic combination. Standard & Poor’s has warned recently of an infrastructure “bubble”.

Macquarie’s investors, both retail buyers of the listed funds and pension funds, look particularly exposed. They’ve been told infrastructure is a safe investment which can withstand an economic downturn. That’s questionable since many of Macquarie’s infrastructure investments have been bought at high prices and leveraged to the hilt. Exotic financial structures, such as the non-amortizing loans used by MIG, have stretched these risks far out into the future.

The bank says it has hedged most of its interest-rate risk over the medium term and that infrastructure revenues tend to rise in line with inflation. However, Macquarie also uses non-amortizing term loans which require all the principal to be paid back on a specified future date. These bullet loans expose investors to what’s called “refinance risk”, namely the danger that credit may be either more expensive or less available when the loans come up for renewal.

There’s also regulatory risk to consider. For instance, there’s a chance that the UK regulator will reduce the permitted returns on Thames Water when the next review takes place in a couple of years. What’s more, during its recent period of hyper-growth Macquarie has stretched the definition of infrastructure to include telephone directories (Yellow Brick Road), roadside restaurants (Moto), airlines (Qantas), bus services (Stagecoach), elderly care (Leisureworld) and airport trolleys (SmartCarte). The firm even justified a failed bid for the London Stock Exchange on the grounds it constituted “financial infrastructure.”

Macquarie boss Allan Moss has elaborated a “theory of adjacency” to rationalise this drift away from pure infrastructure. After all, trolleys are found in airports and cafes by motorways. Macquarie claims to be investing in “privileged assets” with limited competition. But these new business lines have increased what’s called operational risk. There’s no getting away from the fact that airlines, which regularly go bust, are less stable businesses than airports.

Given the complexity of Macquarie’s holding company structure, investors are forced to rely on the valuations provided by the bank. These inevitably involve a degree of subjective judgment. There’s a danger that revenue growth forecasts could too optimistic or risk premiums too low. However, since Macquarie doesn’t reveal all its valuation inputs, it’s hard for outside investors to judge for themselves. There’s a name in finance for situations such as this. It’s called “model risk.”

Read the full 5000-word essay –The Financial Wizards of Oz: Not making sense of Macquarie’s complex business model — here