Macquarie's aircraft to auto leasing seen fuelling earnings

BC-MACQUARIE-LEASING-1 c.2015 Bloomberg News (Updates bond yields in the 12th paragraph.) By Narayanan Somasundaram and David Fickling (Bloomberg) - Macquarie Group Ltd's leasing and lending business is becoming a key driver of earnings as Australia's biggest investment bank makes the most of cheap funding to bolster returns.

The net income contribution from the corporate asset and finance division will climb to A$1.5 billion (S$1.57 billion) by 2017 from A$1.1 billion in the year ended March, according to the average estimate of five analysts surveyed by Bloomberg. It will rival asset management as the largest source of profit by then, the survey showed.

Macquarie has made use of abundant liquidity in debt markets to finance a more than tripling of its portfolio of planes, equipment and commercial real estate loans in the past six years. Chief Executive Officer Nicholas Moore doubled down on the business with his US$4 billion purchase of aircraft in March, while at the same time making cuts in investment banking.

"It's a perfectly logical move by Macquarie to make the most of the low global interest rates," said Angus Gluskie, managing director at White Funds Management Pty in Sydney, who oversees about US$550 million including Macquarie shares. "The expansion in leasing and lending will solidify their near-term earnings growth."

Macquarie isn't alone in wading into leasing. Asian banks such as Sumitomo Mitsui Financial Group Inc. and Bank of China Ltd. are also building their leasing operations as firms like Royal Bank of Scotland Group Plc pull out to shore up capital amid tougher regulations.

Sydney-based Macquarie's corporate asset and finance division, led by Ben Brazil and Garry Farrell, had A$29 billion in assets and loans as of March 31, more than tripling in size from six years earlier.

The projected increase in profit from the division would take its contribution to 31 per cent of total earnings across all business areas, up from 27 per cent last fiscal year and just 4.5 per cent in the year ended March 2009. Net income contribution excludes corporate costs, employee bonuses and tax.

As well as cheap funding, Macquarie has benefited from higher yields for aircraft leases and the way it structures its borrowing to fund the purchases, according to CLSA Ltd analyst Brian Johnson.

"Cheap, non-recourse debt coupled with high leasing yields does the trick," said Sydney-based Johnson, who has a buy rating on the stock.

While Macquarie doesn't disclose leasing yields at its plane unit, returns at some of its biggest competitors are growing. AerCap Holdings NV, the world's largest independent aircraft lessor, saw its portfolio yield climb to 13.5 per cent last year, the highest since 2009, according to filings.

The whole industry has benefited from low funding costs and rising leasing yields, but the strength of Macquarie's balance sheet has given it a particular advantage.

The yield premium over Treasuries on Macquarie's US$750 million of January 2021 senior unsecured notes has shrunk by more than half over the past two years to 181 basis points on Monday, according to Trace pricing. The equivalent spread on AerCap's US$1.1 billion May 2021 paper was 232 basis points.

And Macquarie has been aggressive in using external funding, rather than its own capital, to finance new leases.

When Macquarie announced plans in March to buy 90 aircraft from AWAS Aviation Capital Ltd for US$4 billion, it said the transaction will require A$600 million in capital, about 12 per cent of the total, with the rest coming from existing resources and third-party financing. The deal alone will add 5 per cent to Macquarie's earnings per share in the first full year following the acquisition, it said.

"What's important for us in terms of risk is our ability to hold and fund these aircraft without difficulty in any downturn," CEO Moore said in an interview on May 8. "We are buying the assets to hold on a long-term basis and therefore we are funding them in the long term."

External funding made up 44 per cent of Macquarie's asset finance portfolio as of March, up from 42 per cent a year earlier, according to filings.

High leasing yields combined with efficient use of capital have helped bolster Macquarie's return on equity relative to its peers, said Omkar Joshi, an analyst at Watermark Funds Management in Sydney who has studied returns in the leasing industry.

ROE for Macquarie's so-called annuity-style businesses - asset management, lending and leasing, and retail banking and wealth - was about 23 per cent in the year ended March 31, up from the 20 per cent nine-year average, a company presentation shows.

That compares favourably with the average 12.5 per cent ROE generated by nine of Macquarie's corporate and asset-financing peers, including AerCap and Orix Corp, Joshi said.

Macquarie has also seized on opportunities to acquire discounted assets from companies that were short of cash or looking to exit the market altogether.

In 2009 and 2010, it boosted its fleet of motor vehicles by acquiring more than 100,000 cars from companies that were pulling out, including Ford Motor Co's Australian credit unit.

Macquarie bought three aircraft from AirAsia X Bhd last year when the airline co-founded by Tony Fernandes needed money. In doing so, it got new planes at prices available only to Airbus Group SE's largest customer.

"They know they'll never be able to get the rate that we pay" by dealing with manufacturers directly, AirAsia X acting Chief Executive Officer Benyamin Ismail said in an interview. "They're smart."

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