Corporate Strategy Weekly Radar Update

Week ending Friday 20 April 2012

Highlights Financial Services ANZ hiked its lending rates by six basis points, putting into effect its decision to break-up from the RBA cycles. BOQ, also announced out-of-cycle rate increase wowing not to follow the RBA unless markets suffer a major shock. BOQ also announced a wellflagged $90.6m loss for the February 29 half-year (due to plummeting property values and a sharp increase in problem debts), and confirmed that loan arrears were stabilising. BankWest was added to the excessive penalty fees class action aiming to recoup $220m from 8 banks (ANZ, CBA, Westpac, NAB, Citibank, St George (owned by Westpac) and BankSA). QBE and IAG both make parental leave announcements: o QBE announced a keeping in touch program for employees taking parental leave. o IAG aims to fill 33% of its senior management positions with women executives by 2015 and started a scheme of 20 weeks parental leave for primary care-giver (14 weeks departure and 6 weeks double pay on return) and 3 weeks for secondary carers. HSBC Credit cards research: the number of mid-range card holders has dropped 14% since 2009, while low-fees cards are up +13%. Only those who use their credit cards extensively will hang on to their platinum cards thanks to more tangible rewards. The Big4 are expected to pay $9.2Bn in half year dividends, compared with $8.2Bn last season. But analysts note that "their prospects for capital growth remain questionable". For the major banks, total dividend income paid in FY12-13 financial year is to increase by 4.4% to $18.6Bn from the current financial year, according to Bloomberg. Earnings per share are predicted to climb 4.6% on average. (see appendix) The Royal Canadian Mint enlisted 500 hackers in a contest to develop a digital currency called MintChip. Still in research & development phase, MintChip will ultimately let people pay each other small transactions directly using smartphones, USB sticks, computers, tablets, etc. Other industries Telstra pledges a ruthless focus on cutting costs, mobile margins and bundling of services to counter the demise of traditional earnings generator. The decline of fixed lines, due to mobile substitution, is costing $500m a year. Telstra's strategy to cut costs to free funds and compete in mobiles (they spent $1Bn, mainly on handset subsidies). Virgin seems to enter a price war with Qantas to attract more corporate customers. This is prompting Qantas to put on more aircrafts: there will be 21% more seats available in September than in the same month last year. Australian Government - Global Despite April RBA minutes implying the strength of the economy has been overestimated, a future interest rate cut still depends on CPI. Australian Govt Gross Debt has grown from $117B in Dec 2009 to $237B in Mar 2012, getting closed to the Federal Governments $250B debt ceiling. In parallel Shadow Treasurer Joe Hockey called for social spending cuts, ending the "age of entitlement" in a prominent speech in London. IMF warns of lower commodity prices: context in which BHP slows down approvals of large projects (incl. Port Hedland, WA; expansion of Olympic Dam, SA or the construction of the Jansen potash mine in Canada). Sydney 2nd airport: Transport Minister Anthony Albanese declares Wilton (80km from Sydney CBD) as preference, whilst NSW government suggests upgrading Canberra airport with a high speed train to Sydney. Greens leader Senator Bob Brown retired after 16 years in Federal Politics. Argentina seized control YPF, the countrys largest oil producer and subsidiary of Spains Repsol, illustrating global backlash of govt trying to regain the "upper hand" against the pressure of markets. Insights ANZ rate hike: 1) It will improve the ANZs profit margins (a focus as revenues are growing slowly and the historical returns on shareholder equity is difficult to maintain). 2) It reinforces ANZs argument that there is a disconnect between the bank lending rates and the cash rate that the RBA targets. 3) it amplifies the pressure on the RBA to cut rates in May, which still depends on CPI. Bank fees class action: A combined 171,000 customers are now suing. The Big4 have charged more than $1.3Bn in exception fees in 2008-09. st BOQs recent loss was the 1 experienced by an Australian bank in two decades. Is their reluctance to pursue out of cycle rate increases sustainable given their financial state? Credit cards: Canstar's view is that people who spend under $12,000 a year or struggle to pay off their monthly balance should steer clear of cards offering high-flying rewards. Australias total credit card debt has ballooned to $36Bn ($4700 per card holder - 1.6 credit cards per person). However card adoption is receding from its 2010 peak, when 21% of Australian card holders claimed they intended to apply for a new card. The big4 are likely to maintain their dividend payout ratios this reporting season, but could lift them in future. Analysts believe that as we come closer to APRA finalising capital standards, banks might make increases to their dividends to demonstrate strength in their underlying businesses, and to show they feel comfortable about their capital positions. Mastercard-Visa already have contactless cards for small payments at Point-of-Sale. PayPal, Google and Visa have introduced digital wallets where consumers control all their cashless payments from one place. The difference is MintChip doesnt plan to link to a bank account or credit card information. And unlike BitCoin peer-to-peer digital currency with a fluctuating value, MintChip is simply a enhanced way to exchange existing dollars (and will be backed by the government.) Australian Government Debt: The rise in Gross Debt has been driven by stimulus spending in response to the GFC, and increased capital works (e.g. Clean Energy Program, NBN). Overseas investment in debt has been driven by our AAA credit rating. (See appendix) 10% fall in commodity prices since Sept is to result in a fall in Australias terms of trade Greens leadership: 1. commentators questioned the impact on the balance of power for the Labor minority govt. 2. Bob Brown managed to bring into the parliamentary system a movement born outside of it. Christine Milne will face 2 schools of thoughts: continue in that direction or go back to a more activist approach.

Appendix: a snapshot of the Debt, Deficit, Budget Surplus, and the Age of Entitlement debate. The IMF is warning of lower commodity prices, which is a major engine of growth for Australia A 10% fall in commodity prices since the Sept quarter is to result in a fall in Australias terms of trade the ratio of prices for exports such as coal to prices for imports. Economists observe that typically, slumps in commodity prices last 2 to 3 years and cause prices to fall by 40% to 50%. Such a fall in prices cuts 0.5% to 1% of growth from the economies of exporting nations (most of which are developing countries, with the exception of Australia). The other risk is the ''pro-cyclicality" of metals and energy (the raw ingredients of industrialisation) that tend to be closely entwined with the global business cycle Ultimately the future direction for commodity prices will depend on China's soft growth landing in 2012: its growth should be between 8.2% and 8.5% in 2012, which a number of commentators think will sustain. Whilst it bears not comparison to the levels reached in Europe and the US, Australia's Debt has also expanded during the GFC Total commonwealth debt has grown from $117Bn (2009) to $237Bn (2012) The Australian debt owned by Asian investors increased from 5.8% in 2009 to 12.9% in 2012. Overall, overseas ownership of the federal government's debt rose to 75%, from 35% in 2003. Because number of major countries, especially the US and France lost their prized AAA-credit rating, this has benefited Australia still holding a AAAA. Analysts also note that it makes no difference who ultimately held Australia's public debt: the increased participation from central banks and sovereign wealth funds is arguably a good thing because their decisions are less prone to sudden reversal". It is in this context that the Australian federal government is committed to bring its budget into surplus in 2012-13, as an implied prerequisite for good economic health. However history shows that the need for a surplus is more nuanced than what is commonly reported Off the back of the 1990 recession, the Federal budget went into deficit in 1991-92 and stayed so until 1998-99. Counter intuitively, from 1992-93 to 2000-01 Australia's GDP grew annually by around 4% each year. It was the longest run of above trend-growth in the past 40 years. Of course GDP doesn't tell the whole story, and in the 1990s it certainly did not tell the story of lack of employment growth. It does however give an indicator of the broader picture and the GDP growth of the early-mid 1990s did eventually flow through to the employment sector. What the graph also shows is that if this year's GDP growth comes in under 3%, it will be the first time in the past 40 years that there has been 4 consecutive years of below trend growth The Government hopes such a scenario will not continue and in the Mid-Year Financial Outlook last November, they forecast GDP growth in 2012-13 at + 3.25%, thus being "on trend", which is also part of how they justify their decision to put the budget back in to surplus. Source: ABS and Treasury

It is also in this context that Shadow Treasurer Joe Hockey called for social spending cuts, ending the "Age of Entitlement" prevalent across Western democracies (incl. US, Europe, Australia) in a speech given at the London Institute of Economic Affairs Hockey contrasts the culture of universal access to payments and entitlements from the state with the concept of ''filial piety'' thriving across Asia where people get what they work for and families look after their own, "which at times, seem brutal but works and it is financially sustainable." He links it to "the sovereign debt problems we are seeing in Europe and the US today are the outcome of countries wanting a lifestyle they cannot afford but are quite happy to borrow from others to pay for.": a burning topic in the current macroeconomic context. Joe Hockey calls to bring 16% of GDP that Australia currently devotes to social spending in line with Koreas figure of around 10%. However, in Australia counter intuitively most of this budget does not go to "perk for voters" (such as the baby bonus), but 2/3 go to health and old age assistance (which consists mainly of the aged pension). This means that even if Australia eliminates all social spending other than Health and Old Age Assistance, social spending would still be at 10.1% of GDP, well above Korea A second counter intuitive data point reveals that Australia's social spending is actually quite low among OECD countries: lower even than the United States (as a proportion of GDP). Source: OECD Finally, the analysis of the middle- and upper-class welfare for working-age families in Australia since 1982 also reveals that there are not a lot of low hanging fruits left to cut. Australia doe not spend a lot on middle- or upper-class welfare: this is because payments are tightly 'means tested' and therefore reduced at a rapid rate when people start earning an income. This means that achieving such cuts will put more pressure on the middle class and will result in an increased polarisation of the debate on social cost and how to fund it. In a post-GFC environment some such as Joe Hockey warn that "financial markets impose fiscal discipline on countries. Because a country which is viewed as approaching its safe limit for debt will find it increasingly difficult to borrow funds at an affordable rate, and eventually the capital markets will close." They view this "as a healthy development, ensuring that countries do not exceed their capacity to service and repay debt." Others do not agree and advocate interventionist policies to counter this trend, as illustrated by Argentina's nationalisation of YPF, or the defiance expressed against the financial markets during the French presidential campaign. Ultimately this debt issue and the provision of social services has direct consequences on Insurance companies and Banks, which are in a broad sense part of the same 'value chain' to protect and grow the financial wellbeing of their customers. Those companies have to understand the issues at play and to adapt their models to keep delivering their purpose.

Source: OECD

Source: Whiteford, Redmond and Adamson 2011, table 1.