Corporate Strategy Weekly Radar Update

Week ending Thursday 05 March 2012 (due to Good Friday)

Highlights Financial Services Japanese banks have cash surpluses and planning to make an aggressive push into Australia: o Sumitomo Bank and the Bank of Tokyo-Mitsubishi increased lending in Australia by more than $2Bn in the year to the end of Feb, Mizuho Corporate Bank by $1Bn. o Whereas European banks have withdrawn out of Australia in recent months as they pull back to their home markets. ANZ is selling home loans at a faster rate than rival: it grew its mortgage book 11% over the past 3 months on an annualised basis. NAB, which had dominated the home lending over the previous 2 years, has slowed its growth to 6%. CBA grew mortgages at 5% and Westpac 3% on the 3-month annualised comparison. In the last quarter of 2011, Australian households saved $20 billion, 10 times as much as the same period in 2005. CBA is leading the deposit volumes and have doubled since 2007, growing at 10% a year. Respite for some financial institutions from Basel III in Australia: o From 2013, banks will need a minimum common equity tier 1 ratio of 4.5%. Other institutions will phase the requirement over 3 years. o The 6 largest banks (incl. Macquarie Groups banking unit and Suncorp) already have an average tier 1 ratio of 6.9% o Local banks will need a minimum ratio of 7% from 2016, plus an informal buffer, which would require 8.5% in total. Industrial Relations: Banks are pushing for notional weekends - to include Saturday afternoons and all of Sundays, in a bid to improve flexibility of rostering employees on weekends. Other industries Australias capital cities are not prepared for the growth in demand for their ports and airports, according to a review of state planning systems. Sydney and Melbourne were among the worst when assessed against criteria agreed by COAG in 2009 to improve the global competitiveness, productivity, sustainability and liveability. Anecdotal: CSIRO wins legal battle ($220m) over wifi patent, which the Australian scientists invented in the 90s. This brings the total revenue earned via wifi to $430m Australian Government - Global RBA leaved the official cash rate on hold at 4.25% and is waiting for the March quarter CPI inflation data, due later in April, before revisiting the need to cut interest rates. Housing affordability - McKell Institute report on housing affordability (see appendix) + risk of a rental crisis: despite falling house prices, the phenomenon of increasing rents has bee occurring around the country. Follow-up on the "bonds vs shares" theme from last week: o Markets for equities, bonds and currencies are the calmest theyve been since 2007, making some investors nervous. o Former federal finance minister Lindsay Tanner is calling for government to intervene to shift the bias of superannuation funds away from shares to corporate bonds. He believes the $1.3 trillion super industry has put the publics savings at risk because of "narrow investment focus" on equities. The political pressure on Gillard govt after Labor's defeat in QLD, carbon package, the pressure to "not wreck the economy for the sake of a surplus" and the Craig Thomson investigation. Europe's issues seem to now be transferring to Spain: o Spain now has 25% of its working population unemployed. 50% for the under-25s Japanese Banks: The move into our local market is likely to oppose Japans banks against Australias big four, though the push by the overseas groups is likely into business lending rather than home loans. ANZ had benefited from greater discounting and re-engagement with the broker channel. Still, ANZ has the lowest mortgage market share of the big4. Suncorp Bank posted a 13% surge in mortgages. Along CBA notable examples of banks exploiting this surge of savings are ING and Ubank. Launched in 1999, ING persisted through the years when Australias savings rate was low and/or negative, and now has $27Bn in its wholly online accounts. Devising a strategy for this market is a strategic imperative for all players. Basel III: Australian banks should reach this threshold through retained earnings. IR: The big4 employ a combined 150,000 people and argue they are in same position as retailers, telecos and call centre operators but have less flexibility on weekends. The FSU argues that it is the 1st of a 2-step plan to abolish penalty rates for working on weekends; which is denied by the banks. Insights

RBA: o Some economists have called for a long-term reform plan to make labour laws more flexible and reduce handouts to failing industries, after the central bank linked interest rate cuts to further productivity growth. (Productivity theme to be developed in the next weeks) o Anecdotally unlike most countries, in Australia the ABS releases CPI quarterly, not monthly, hence the need to wait the RBA invoked The pressure on the federal government has increased with the possibility of Craig Thomson going on trial: this could shift the parliament majority. Spain is suffering from a policy mix: o France and Germany promoting labour market reform as well as much tighter controls on fiscal deficits. Both are logical longer-term goals, but they augment the recession. Spain is rolling out both. Consequently unemployment had its sharpest jump in Feb following relaxations to labour laws. The 2nd part of the mix delivered 18Bn in budget cuts and 10Bn in tax increases to bring the 2012 deficit back from 8% to 5.3% of GDP. Observers agree that both initiatives are likely to increase the jobless rate and further cuts to an already negative growth outlook.

Appendix: Theme of the week: Australia's Housing market: the dimensions of the debate Undisputed fact: the market is under pressure 1 - Despite falling prices ... 2- ... housing sales are hitting 15-year lows

Analysts and industry parties also report that rental prices are on the high with very low vacancies, some warning that "Australia is on the verge of rental crisis"
Source: RP Data-Riskmark, ANZ

Affordability - The most contentious due to various measures 3 - On one hand ANZ says affordability has improved...

o ANZ explains affordability with two factors: gains in average household incomes and a structural decline in the cost of borrowing. o The median house price has risen by almost 6 times from $93,000 in 1986 to $550,000 now. Over the same period, average household incomes rose by 3.5 times. o They using the house price to income ratio, which says that Australian house prices are currently 40-50% overvalued relative to the 1980s. o However, they also take into account the halving of mortgage rates... o ... and conclude that the average households purchasing power over the median priced home is currently almost exactly the same as it was in the mid-1980s. (Their critiques argue that this is taking a "bank view") 4 - ...on the other hand The McKell Institute concludes in their o The McKell Institute uses the Median Multiple recent report that affordability has suffered. (median house price divided by gross annual median household income - from the Demographia International Housing Affordability Survey) o By this measure in Australia overall it now takes 6.7 times the median income to buy a home. In the UK, its 5 times and in the United States its 3.1. In Sydney, its 9.2. (The long term international benchmark for housing affordability lies somewhere between 2 and 3 times the median household income). o 20 years ago it took 3 times the median salary to buy a house in Sydney. 5 - Another measure is to look at the straightforward proportion of family income devoted to servicing mortgages o There has been a 12-fold increase in the proportion of family income that has to be devoted to servicing mortgages since 1970. o Even compared to the high-interest days of 1990, mortgage debt service is now 2.5 times as important.

Source: Economist Steve Keen

Supply 6 - Shortage of dwellings is differently evaluated, when not contested.

Source: Housing Industry Association

o In Dec 2011, the government National Housing Supply Council released its 3rd State of Supply report estimating housing supply shortage of 214,700 dwellings in 2011 and predicting this shortage will reach 328,800 dwellings by 2015 and 640,200 dwellings by 2030. o The Dec 2011 ANZ Australian Property Outlook estimated the housing shortage at 240,000 dwellings in 2011, to reach 440,000 by 2015. o The Housing Industry Association has more dramatic numbers (but vested interest in construction) with a shortage of 500,000 dwellings by 2020, to blow out to 640,000 within 20 years, with biggest shortfalls in NSW and Queensland. o However other observers contest those numbers and argue that more than 2/3 of the governments shortage estimate arises by including people who cant afford housing, such as the homeless or those living in trailer parks. They argue Australia has more an "affordable housing shortage", not an absolute "housing shortage" 7 - One point most observers agree on is that the explanation due to too many vacancies is "a myth". It has remained around 9%: 830,000 in the 2006 census: Where associations warning of "empty property hoarding" seem to have a valid point is that the 16,400 primary homelessness (sleeping rough ~8,800 households), the 47,300 secondary homelessness ('sharing with friends or relatives' ~35,000 households), and the 17,500 'marginal residents of caravan parks' (~12,500 households) could be addressed with better measures than what is currently done. ... the Australian Market, Real House Prices (capital cities)

Insights US Market compared to ...

Source: ABS

8 - Comparing the US (where the bubble exploded) and Australia: o Australian and US prices tracked broadly similar paths from 1987 until 2005. o Australian prices started from a lower base $100K vs $160K for US and therefore have moved further. o US prices declined by 42% since 2005 and are now back to 1980 levels, whereas Australian prices have only declined approx 7%. o One significant difference between the 2 markets are the core fundamentals which are driving the outcomes: US tax laws but also the non-recourse aspect of US loans, meaning that borrowers are not personally liable (whereas Australia has recourse loans, meaning borrowers are personally liable for the debt). This means that US borrowers can default on their home loan while having other assets protected: this removes the risk from the borrowers and is likely to have influence the evolution of the US market. 9 - Population growth and dwelling completion clearly remain out of sync ie. fluctuations between underlying demand (determined by population growth, demolitions and changes in household size) and supply (starts). 10 - An insight on the Australian market is that not all geographies and demographics are impacted equally, echoing the multi-speed pattern of the economy o Coastal cities are congested and therefore under pressure. o The segments doing relatively well are properties in the upper range. o Properties in the $1-2m range are the former ~$700k-$1m segment and are struggling because the market sees them as overpriced. o Social housing, the lower end and middle of the market are also particularly under pressure. o This situation reinforces the affordability (and perceptions of) for "the middle class", which has fuelled the national debate for some time.
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