Corporate Strategy Weekly Radar Update

Week ending Friday 16 March 2012

Highlights Financial Services The likelihood of a complete exit from the UK market by NAB is decreasing: a reduction in business banking in central and southern England to be a more likely outcome. NAB is also expanding in the US with the acquisition of the minor Iowa lender via its subsidiary Greater Western Bank. The Federal Reserve and Treasury have stress-tested America's 19 biggest banks: 4 failed at least one of the criteria: Citigroup, Suntrust Banks, Ally Financial and the insurance giant Metlife. In the projected scenario the US 19 biggest banks would lose $534Bn over 9 quarters. The AFR reports on Movenbank, an online only platform run on handheld devices, taking advantage of near field communications (NFC) systems at points of sale, with strong links to social networking and a philosophy built around paperless and plastic-less interactions. Movenbank will partner with existing Australian banks to handle back office tasks, risk management and regulatory obligations. Regulations: o FOFA: Assistant Treasurer Bill Shorten announced the implementation of Future of Financial Advice (FOFA) reforms will be pushed back 12 months to July 2013 following industry concerns. o LAGIC - Solvency II: after the 2 major parties agreed a package, the EU Parliament is likely to pass measures easing the capital burden for insurers. Solvency II is due to become law in Jan 2013 a year before full implementation. Insurers will need to hold capital in strict proportion to the risks they underwrite, replacing a patchwork of less sophisticated national rules. However they feared higher capital requirements would push premiums up. Broadly, the agreement allows insurers to hold less capital against annuities, and to hold countercyclical premiums to smooth out the capital impact of short-term market fluctuations.. Other industries Myer reported a 19.8% decline in 1H profit to $87.3M (below the $94.2M expected by analysts) with higher rent, labour and depreciation costs compounded by total sales falling 1.7% to $1.7B. Mining CEO Clive Palmer will challenge the constitutionality of the governments carbon pricing regime in the High Court. Encyclopaedia Britannica announced move to digital only future, with no more print editions to be produced. Anecdotal item: One Apple share now costs more than an iPad ($US600) Australian Government - Global New homes construction drop: Despite two consecutive RBA interest rate cuts in late 2011, dwelling starts fell 6.9% in the Dec quarter, following a 5.8% drop in the Sep quarter (seasonally adjusted). Qld led the fall, with a 17.9% drop in new dwellings in the Sep quarter. The Westpac-Melbourne Institute Consumer Confidence Index dropped 5% from February. It is now lower than in Oct 2011 when the RBA began cutting the cash rate, and coincides with moves independent of the RBA by lenders in raising variable home loan rates in February. David Gonski is appointed chairman of the $73 billion Future Fund replacing former CBA CEO David Murray. The Fund targets 4.5% afterinflation. So far it has followed a higher-risk, higher-return strategy in the belief that short-term losses will be ironed out in time. Since 2006 it has has averaged 4.2%/year. However in 2011, it was down to 1.6%, and minus 3.1% in the past 6 months. China (see Appendix for more insights) o Bo Xilais ousting from the Communist Party secretary is seen as victory for Chinese reformers. o Fears of an economic hard landing are increasing Insights No US bank was asked to recapitalise. So despite the failure of Citi (tier-1 capital ratio at 4.9% instead of 5% and leverage ratio was 2.9% instead of 3% minimum), commentators believe that the US provided further evidence as to why, despite continuing weak economic conditions, it hasnt descended into the economic and financial nightmare that is Europe, where all banks must recapitalise. (See Appendix for more details) After initially targeting New York, San Francisco and London for the density of their NFC readers, Movenbank is aiming to launch Australian operations in 2013. Is there scope for Suncorp Bank to become an Australian partner, enabling Suncorp to access contactless payment systems and the burgeoning market of tech savvy customer segments? FOFA: Delay widely heralded by industry, with the reforms will result in substantial system, process and business model changes that will take time to implement. LAGIC - Solvency II: the new package is seen as an important concession to the insurance industry. It will not postpone regulation, but could lead to a shortening of the time period between the date that the legislation is transposed into national law on 1/1/2014. Impact of Solvency II rules beyond EU borders: insurers operating in Europe will need to conform, whilst those not directly touched may be able to seize competitive advantages from rivals subject to the new rules. In a seemingly unrelated manner the juxtaposition of Myer and Palmer illustrate the changes happening in Australias economy: the challenges faced by the old economy and the growth of the mining and resources industry that is increasingly demanding a voice in driving the national agenda (cf. Rinehart asking a seat at the Fairfax board) The apartment sector has fared worse than private home construction in the past year. The removal of the last planks of the government stimulus is also flowing through in the public sector, which usually has a high degree of apartment buildings. Commentators are noting that while mining, business investment and exports as a share of GDP continue to surge, dwelling investment as a share of GDP in 2011 was 3%, levels usually associated with an outright recession. Australia needs to build 200,000-plus dwellings each year for a number of years to catch-up with its dwelling deficit. Future Fund: aside from the political controversy surrounding Peter Costellos oversight for the role, the investment strategy of the Future Fund is likely to be reviewed. Gonski could ask whether the push into alternative strategies and private equity should continue given the lower returns hedge funds have been posting since the GFC, and a possible longer wait for private equity paybacks post-crisis.

Theme of the week: Chinamerica Appendix A China. Two dynamics in the media:
1- The health of the Chinese economy is an increasing worry: Chinas problem has been that exports have far exceeded imports (ie foreign purchases). This pushed the US to pass a bill this week allowing them to impose tariffs on countries like China, when they dump/subsidise goods on US markets. However this year, the rebound of Chinas trade balance, which often dips around Chinese New Year, only happened for imports, not exports. Chinas weak exports are contributing to a slowdown in the broader economy: Chinas industrial production grew by 11.4% in January and February, much slower than its normal pace of about 15%. China is said to be rebalancing, i.e. correct its external imbalance. However China has rebalanced externally without rebalancing internally: its current-account surplus has narrowed largely because of an increase in domestic investment, not consumption, which would be the necessary force to help fix the global economy. Another twist to the story is that Chinas investment boom has concentrated on roads, railways and houses (50% of loans in 2009), not factories (10% of loans in 2009). In his annual review this month, Prime Minister Wen noted that China had shut down outdated factories, which contributes to rationalise heavy industries and to remove excess capacity aiming at preventing a repeat of the big external surpluses of past years. The problem? It is yet to be seen if this will restrict the export of rare earths products (such as tungsten or molybdenum used in the manufacture of many high-tech goods including fluorescent lights in the west). 2 Western media are bridging the gap between the lack of knowledge of the Chinese system at its global importance: The publicised ousting of Bo Xilai from the Communist Party secretary is a sign of such a trend. A measure of how far China has come from... A recent change in Chinas trade balance

Chinas current-account surplus (a broad measure of the countrys external payments and receipts for goods and services) is declining: Chinas prime minister Wen Jiabao suggests this means the yuan is close to its equilibrium level

An historical perspective: China is reclaiming her lost seat at the global table. This chart shows that China Inc. has been undervalued since the 1850s. It is now catching up with this gap, meaning that it is reasonable to believe there is room for growth built in the system.

Appendix B US Federal Reserve Stress Test (informative to compare with our own)
19 Bank Holding Companies (BHCs) were required to participate in the Comprehensive Capital Analysis and Review (CCAR 2012). In early January, these BHCs submitted comprehensive capital plans to the Federal Reserve, describing their strategies for managing their capital over a 9quarter planning horizon. The Federal Reserve projected losses, revenues, expenses, and capital ratios for each of the 19 BHCs under adverse macroeconomic scenarios including: Real and nominal GDP contraction over the period 4Q11 to 3Q12, the largest contraction seen in 1Q12 at -7.98% and -5.39% respectively. Unemployment rate rising above 10%, peaking in 2Q13 at 13.05%. Housing prices dropping 21%. Dow Jones dropping below 13,000, with the lowest level seen in 4Q12 at 5,668. Various GDP growth slowing / contracting and deflationary pressure scenarios experienced in the Euro zone, UK, Japan and developing Asian regions. Following analysis undertaken by the Federal Reserve, 3 banks fell below the 5% Tier 1 benchmark (Ally Financial, SunTrust Banks and Citigroup) and, along with Metlife (which fell below the risk based capital benchmark) are now required to submit revised plans. However, none of the institutions were required to capital raise, unlike in 2009 where 10 institutions were required to capital raise. The results across all institutions are depicted in the exhibit below.
16.0 14.0 12.0 10.0 8.0 6.0 4.0 2.0 0.0
Fifth Third Bancorp The Goldman Sachs Group, Inc. Morgan Stanley Regions Financial Corporation American Express Company Capital One Financial Corp JPMorgan Chase & Co. SunTrust Banks, Inc. Ally Financial Inc. U.S. Bancorp MetLife, Inc. Keycorp The Bank of NY Mellon Corp Bank of America Corporation PNC Financial Services Group, Inc. State Street Corporation Wells Fargo & Company BB&T Corporation Citigroup Inc.

1Q12 Tier 1 Common Ratio

Tier 1 Common Ratio in the Supervisory Stress Scenario (4Q14) 5% benchmark

Source: Federal Reserve. Comprehensive Capital Analysis and Review 2012: Methodology and Results for Stress Scenario Projections; 13 March 2012, p25.