Brains behind MacBank's taxpayer bonanza

The 38-year-old Brazil is a key figure in a little-known jewel in the Macquarie empire called the Corporate and Asset Finance division. Over the past year, the division tripled its profit, buying discounted cash-generating assets such as loan books or leasing businesses with cheap funding provided, in part, by the federal government's wholesale funding guarantee.

The plan was simple. The bank could raise money cheaply under the Australian government guarantee and CAF deployed it, at times offshore, for a profit, cashing in on the ''spread'' - the difference between the cost of getting the money and the return.

In the midst of the crisis CAF bought a multibillion-dollar plane- leasing book from financial crisis victim AIG, $1.8 billion in European loans and a $500 million US information technology leasing business.

CAF's extraordinary rise saw its profit surge to $264 million from $66 million last year. Its operating revenue - pre-tax and pre-Macquarie's famed bonus pool - more than doubled, up 116 per cent to $456 million.

Macquarie says CAF contributed 10 per cent of Macquarie's $1 billion net profit. Its operating revenue contribution appears to be significantly higher. CAF is forecast to grow strongly in coming years.

Macquarie borrowed more than $16 billion under the government guarantee. It is not known how much CAF deployed under the program but Macquarie has disclosed that in 2010 CAF ''originated or acquired in excess of $7.5 billion of corporate debt and lease loans''. It also funded $1.8 billion of ''corporate debt and leasing opportunities'' in Europe.

In total, CAF grew its loan and leasing finance businesses to managing $13 billion.

At a time when the bank faced the collapse of its ''Macquarie model'' of fee-generating listed infrastructure trusts, Brazil began spearheading a drive to reinvent the bank's profitability using a turbocharged commercial lending strategy that taxpayers have unwittingly supported.

Macquarie's aggressive use of the taxpayer guarantee to bankroll profits has raised questions about whether it fits with the government's original intentions of ensuring financial stability. Reading the bill into Parliament in 2008, the Treasurer, Wayne Swan, stressed its purpose: ''The government has announced unprecedented action to deal with developments in global markets to ensure stability for Australia's financial system, to maintain our institutions' ability to attract new funds for investment in the Australian economy, and to enhance and strengthen Australia's regulatory framework for managing financial institutions in distress.''

Mr Swan is understood to be privately furious at Macquarie's use of the guarantee.

All loans made by banks under the wholesale government funding guarantee using the taxpayer guarantee put the AAA rating at risk until the loans are repaid in full. Macquarie, with $20 billion in deposits, was among the biggest users of the guarantee, outborrowing the NAB, which has $205 billion in deposits.

The origins of CAF's rise lie at the height of the global financial crisis in September 2008. As BusinessDay revealed earlier this month, Macquarie undertook a lobbying effort with regulators and government as hedge funds mauled its share price, sparking a crisis of confidence.

Within days ASIC banned short-selling, and within weeks the government introduced the wholesale funding guarantee.

At the time, credit markets were effectively closed to banks such as Macquarie that had an A-rating, leaving banks struggling for finance. But under the guarantee, banks could use the (taxpayers') government-backed AAA rating, which allowed banks to access money at a cheaper rate to stabilise the market and continue operating.

An analysis of Macquarie's disclosures over the past 18 months reveals that two weeks after Lehman Brothers collapsed in September 2008, Macquarie quietly conducted an internal shuffle that hived off CAF from the non-bank side of the business to the bank.

The move, on the day Macquarie closed its books on September 30, had the effect of shuffling a cash-generating business on to the balance sheet of Macquarie Bank.

As the CAF business focuses on leasing and loan financing, it is reliant on cost of funding and it would be cheaper to borrow it under the banner of the bank. Whether it was by design or just good luck is not clear - but it turned out to be an incredibly fortuitous move.

Two weeks later the government introduced the wholesale funding guarantee. Enter Ben Brazil. He is understood to have joined the division some time after it was hived off from Macquarie Capital, putting investment banking firepower onto the commercial side of the business.

Brazil was appointed to the board of James Packer's Crown Casino last June and his director's biography identifies him as an executive director in Macquarie's Corporate and Asset Finance division.

Brazil was hired by Macquarie straight from university and was quickly adopted as a protege by Nicholas Moore, now its head.

Over the past decade Brazil has reportedly moved between the Packer empire and Macquarie. At the height of the market boom in 2007, Brazil bought a $16 million Sydney Harbour waterfront property in Vaucluse.

Senior bankers say Brazil was the brains behind the idea to use the government guarantee to buy leasing and loan books below cost. As one describes it, Brazil has been ''going around the world hoovering up assets''.

The ''Brazil Book'', as it is known by some, has been undertaking secondary debt acquisition and also plenty of primary lending, both domestic and offshore.

Among its targets were businesses that wanted to exit their leasing and loans books.

Macquarie figured there was money to be made buying loan and leasing books below cost. Rather than pay 100¢ in the dollar of a loan book, they would pay a steep discount at a time when the value of many loan books fell to 70¢ in the dollar and lower.

The attraction? As borrowers still pay the same amount of interest on their loan, Macquarie's yield becomes much higher.

But Macquarie could also finance deals more cheaply and increase its margins even further.

There is also the potential for revaluing a rebound in the loan book's asset values as profit in the bank's profit-and-loss account.

Still, given the decision of experienced industry players to get out of the market, Macquarie's investment reveals the bank's ongoing strong appetite for risk - even if it is ultimately underwritten by the Australian taxpayer.

Despite the availability of the wholesale funding guarantee, BusinessDay understands Macquarie was actually slow on the uptake. Figures lodged with the federal Treasury show that Macquarie didn't make its first application under the long-term wholesale funding guarantee until December 2008.

An analysis conducted by Deutsche Bank of the government guarantee program shows the attractive rates at which all banks, including the banking side of Macquarie, were able to raise money under the guarantee.

On December 11, 2008, when Macquarie raised $US2.1 billion under the guarantee, Deutsche calculates the rate was 160 basis points over the swap rate. But by Deutsche's estimates, at the height of the crisis that kind of deal would have cost about 70 to 90 basis points more on-market without the government guarantee.

Macquarie has paid $200 million to access the government wholesale guarantee.

The two major acquisitions Macquarie has disclosed for CAF in the past year are a $1 billion portfolio owned by Ford Credit Australia in October 2009, and a $1.7 billion plane leasing portfolio which CAF acquired from AIG of the US earlier this year.

In a series of disclosures, Macquarie has detailed the rise of the CAF division, making limited commentary on its funding and profitability.

Macquarie's 2010 annual report says CAF originated or acquired in excess of $7.5 billion of corporate debt and lease assets last year. In its latest accounts, Macquarie disclosed that CAF managed a lease and loan portfolio of $13.6 billion, an increase of 61 per cent on the year before.

The history of how CAF came to be on the banking side of the Macquarie Group business is only revealed in footnotes to accounts.

Macquarie places little emphasis on the effect of the business on the bank's overall profitability.

In one disclosure it notes that the bank's average margins increased from 268 basis point to 294 basis points, noting only: ''The increase in average margins can be largely attributed to an increase in higher yielding Corporate and Asset Finance loans.''

Senior banking sources both inside Macquarie and outside say the Brazil Book is averaging a spread of as much as 400 basis points.

Macquarie's description of the business is modest. ''The expansion of CAF's corporate lending activities during the year was a response to the dislocation of global credit markets.''

With some understatement, Macquarie added: ''The scale-back of lending activities by other domestic and international financial institutions provided Macquarie with the opportunity to acquire or originate quality corporate loans at attractive net interest margins.''

The business is expected to enter a sweet spot in the next few years. Already Macquarie is forecasting the CAF division's 2011 earnings ''to be significantly up on the prior year''.

''The division will continue to actively seek further acquisition opportunities. It expects continued growth in its existing businesses and further expansion into new geographies and asset classes.''

So significant has CAF become to the bank that its divisional head, Garry Farrell, was invited to address analysts at Macquarie's recent result. His presentation gave little indication of the significance of the division's contribution to the group.

A Macquarie spokeswoman, Lisa Jamieson, said: ''The majority of financing by CAF has been to Australian clients, not international clients.'' She did not provide details.

Asked about Macquarie's funding mix since the close of the guarantee, she said: ''CAF continues to operate under the stringent risk control framework it has always maintained and while its loan and asset book has increased, the quality of the book has remained consistent.''

As for Macquarie's funding profile, she added: ''The key point to note is that if you compare Macquarie's total funded balance sheet … pre- and post-government guarantee, there is virtually no change - all that has occurred is that we have conservatively lengthened our funding profile and retained high levels of cash.''