Corporate Strategy Weekly Radar Update

Week ending Friday 30 March 2012

Highlights Financial Services BoQ announced a surprise $450m capital raising to strengthen its balance sheet after experiencing a (rare in Australia) $91m loss in 1H12, due to plunging property prices and soaring bad debts. (This result was driven primarily by $328M in impaired loans, up from $134M in 1H11.) o BOQ communicated on their strategy: changes with plans to return to the broker-originated mortgage market after a long absence, in order to grow their home lending (b.o.m. is 50% of the domestic mortgage market), and plans to introduce 24-hour phone banking. o A confirmation to stick to owner-managed branches (OMBs) (77% to BoQs national network, working on commissions - said to be more productive than the bank-owned branches). Westpac has also been in media focus: o IT: CIO Clive Whincup wants to right a perception that WBC has been behind CBAs headline-grabbing core banking modernisation. o Gail Kellys strategy seems to be under scrutiny too. In retrospect, the price of the $19Bn acquisition of St George (again, compared to CBAs bargain for BankWest) is challenged: it was done when credit growth was stronger, and when growth strategies such as buying banks - and the multi-brand that came with St George - could be undertaken, predicated on revenue growth of 15%, and cost growth of 4%: those assumptions have changed post GFC. o Senior reshuffles have been done as part of addressing those concerns: high profile George Frazis (former NAB, CBA) has been repatriated from NZ to head St George while Brian Hartzer (who was successful at ANZ) will run Westpac's entire Australian operations (overseeing St George as well as Westpac retail). The retreat of foreign banks from Australia has created a gap in the domestic funding markets as corporates look to refinance their maturing debt. Foreign banks held about $240Bn of domestic corporate debt as part of syndicated finance deals in the decade prior to the GFC: the downturn has left a funding gap of at least $34bn. Other industries Chinese giant telecommunications company Huawei has been banned from tendering for the NBN Mining giants Rio and BHP are reviewing their diamond business. Together they accounted for 16% of global diamond production by value in 2010, with mines in Australia, Canada and Zimbabwe. For completeness of record: News Corp is accused of using a hacking unit to promote large scale piracy of pay TV competitors, with the aim of damaging their business while growing in the sector. Australian Government - Global QLD State election: Coalition in power, Labor reduced to 6-8 seats in the 89 seat Parliament, largest defeat in the states history. Carbon policies uncertainty: o The new QLD government is now working on the removal of a number carbon reduction schemes introduced by Labor. o Victoria is also reducing the states commitment to reduce carbon by 20% by 2020. Initial NBN rollout to cover 3.5m premises. New head of World Bank, Jim Yong Kim, US citizen but Korean-born Despite the global worry about the sovereign debt crisis in Europe, analysts predict an improvement of the global economy and the end of a 3-decade bond rally in favour of shares. (see appendix) Insights BoQ: o The capital raising is done at a significant 17% discount ($6.05) and the 74m shares on issue dilute existing shares by 32%. The institutional component of the equity raising has been successfully completed, and BoQs shares leaped +26% to the price being paid for new stock (closed at $7.65 after reaching $7.74) when trading resumed on 28/3. HOWEVER the new shares will only start trading on 5/4 for institutional and 2/5 for retail so it is to be seen if this rise is purely speculative or the markets endorsement of BOQs plans. o It also confirms the appetite for well-capitalised and liquid financial stocks. A similar sized capital-raising in February run by Macquarie was also quickly absorbed. As CSLA's Brian Johnson noted: "Banks are not judged so much on growth prospects any more; it's efficiency and balance sheet strength." (in line with our focus) Westpac: o 2 different IT strategies: CBA has focused on its core for the past 10 years since ComSee, whilst Westpac says it is focusing on the front end systems because that is where the customer sees the benefit directly: IT specialists insist getting the core right is non-negotiable. o In post GFC conditions banks struggle to keep revenue growth above cost growth. Westpacs domestic, retail multi-brand strategy looks an expensive approach in a market that values efficiency, or Asia. Foreign Banks departures from Australia have been led by major French banks Socit Gnrale and Crdit Agricole, both hit hard by the Euro sovereign debt crisis. This has contributed to reinforce the oligopolistic share of the Big4 (80% of loans in 2011) and illustrates a flip side of this situation. Huaweis ban is at the nexus of national security and protectionism, illustrating frictions as Australia finds its foot in Asia, and as China globalises from a lower value offshore destination to a full competitor. Rio could float the diamond business (for which they took a $344m one-time charge to reflect higher costs) in order to focus on the lucrative iron ore that generates 78% of net income, and will expand in Australias Pilbara more than 50% by next year. Does this focus on Australian operations clear, in the short term, fear of offshore moves due to the MRRT? QLD State election results in a 4:4 ratio at state/territory level and confirms the political volatility we previously highlighted. Dual implications on policies for companies operating in QLD, as well as future federal consequences to be monitored. (see appendix) Jim Yong Kims World Bank appointment is a tactical move from Washington to keep American hands on the position, whilst acknowledging the pressure from developing countries to open the position to non "Western" candidates (albeit only being half a step towards a truly non-US/European appointee)

Appendix: Theme of the week: 1 The prospect of a global recovery might reshape the financial landscape, especially ending the 3decade long bond rally shares might see a recovery 1- While the crisis is not over yet, there are signs of a recovery The US housing sector seems to bottom: rise in home builders conditions and falling delinquencies (peaking in foreclosures). The situation in Europe is improving. o The European Central Bank (ECB) has provided cheap three-year funding to Eurozone banks. nd o Greece received a 2 bailout, the portion of its debt owed to private bond holders was by 50%. o The European debt firewall is likely to expand with the combination of the remaining 240Bn European Financial Stability Facility with the new 500Bn European Stability Mechanism which should clear the way for additional IMF support. o Italian, Spanish and French bond yields have continued to stabilise (Graph)

Source: AMP capital Global monetary policy has been easing. o Bank reserve ratios have been cut in China and India. Interest rates have been falling in emerging countries. o The ECB, Bank of England and Bank of Japan have expanded their quantitative easing (pumping cash into their economies). o The US Federal Reserve is working on keeping long-term bond yields down and extended commitment to keep interest rates to near zero until late 2014. 2- Notwithstanding risks still exists (as attested by the 2010 and 2011 midyear dips) .... AMPs Chief Economist Shane Oliver observed that the last 2 years have seen a solid start for shares then drops of ~15%. (Graph). Mainly due to worries triggered by the Euro Crisis, US conditions, natural disasters, surge in oil prices in response to civil wars in the Middle East, etc 3- ... a likely development is a reshape of financial markets: some see stocks as having much better prospects than bonds. Some analysts suggest that a 3-decade bull market in bonds may be coming to an end (The Barclays Capital US Aggregate bond indexwhich covers the investment-grade-bond markets, including govt and corporate bonds has returned 113% since 2000. By comparison, the S&P's 500-stock index returned 19%, including share-price gains and dividends) But because Bonds are fixed income assets, it is likely that investors will look for higher returns and take more risk by switching back to shares. Currently, shares represent 9% of Australias household financial assets (half pre-GFC level). Cash and deposit have jumped to 27% from 19% in Dec 2007: this has created a reserve that could go back to shares. It is likely to also have consequences on pensions in the rest of the world:

2 Balance of power and minority politics in Australia The evolution of the political balance of power: whilst Labor and Coalition are now at 4 state/territories each, the Council of Australian Governments is split between weak Labor governments and strong Coalition ones. Nationally, uncertainty or antagonism have increased in several areas: Carbon packages, as illustrated by: o Campbell Newman will unwind all programs apart from solar subsidies for household rooftops (including: the $1.5bn Solar Flagships Program, Solar Dawn solar thermal project near Chinchilla, closure of the $430m Queensland Climate Change Fund, the $50m Renewable Energy Fund, the $50m Smart Energy Savings Program, etc) o Victoria: the govt is replacing its carbon emission reduction target of 20% with one that looks to reduce greenhouse gases by 5%. The Mining Tax, passed in Senate last week, opposed by the coalition General COAG cooperation: o Colin Barnett (WA): Now with4 big, dominant Liberal-National states, the Commonwealth wont be able to impose itself like before. We might have seen the rise and fall of COAG. o A large part of the federal governments remaining reform agenda requires the co-operation of the states. This includes the proposed new $1.5bn Vocational Education and Training system, the Gonski reforms for schools, Streamlining areas of business regulations and overhauling the distribution the GST revenue to the states.

A bit of a trivia for the weekend: whos who?