Corporate Strategy Weekly Radar Update

Week ending Friday 5 October 2012 (theme: have we reached 'Peak Car'?) Highlights and Insights Financial Services ANZ is confirming its intention to focus on Wealth Management: strategic review of ANZ Wealth to be made public in Nov, appointment of Joyce Phillips as division head in April now directly reporting to CEO Mike Smith (which wasn't the case). o ANZ, via OnePath, has traditionally been underweight in Life Risk (11% market share) and Super & Investments (9% market share): now seeking to capitalise on these growing markets ANZ also plans to reduce property expenses by 25% as part of a $1.5B upgrade to customer facing technology and branch network. ANZ is silent as to whether this would mean branch closures, but indicated that branch footprints (i.e. required retail space for branches) would reduce by 36%. o Bank branches within Australia went through a large reduction in the 1990s, dropping from 6291 in June 1990 to 4712 in June 2001 (-25%). Following community backlash, numbers increased in the 2000s, and stand at 5783 as at June 2012 (+4% yoy, but still -7% below 1990 levels). With branch numbers growing every year since 2003, there is little evidence yet we are likely to see a 1990s style branch rationalisation across the industry. CPA Australia report that the $30B in compulsory super tax breaks is failing to provide enough retirement income and appears to have reduced other forms of saving by promoting a windfall mentality: Retiree are using low-taxed super to extinguish increasing levels of debt, then double-dipping into govt support by claiming the aged pension. o CPA's conclusion is that Super is precisely failing twice at what it was initially designed for: ie to reduce the cost of an ageing population on the budget by encouraging Australians to fund their retirement, rather than relying on the age pension. (twice because govt loses revenue through tax breaks, then has to pay the age pension) Changes advocated include placing limits on lump sum payments and promoting annuity type payments. Symptomatic of Basel III's tortuous implementation, the rules have been surprisingly criticised by Andy Haldane (Bank of England) and Tom Hoenig (US Federal Deposit Insurance Corporation -FDIC) in recent weeks: whilst in favour of reforms both highlight the complexity of the system going for lower ratios and relying too much on complex models "esoteric riskweighted rules, easier for banks to game", and advocate a "higher and blunter" leverage ratio. o Given the tense nature of the Basel III negotiations, and that banks quite advanced in the implementation, a change of course is unlikely but these remarks highlight that the jury is still out on the appropriate regulatory response Mortgage Refinancing grew for the 2nd consecutive financial year (FY12 = 190k, FY11 = 163k, FY10 = 140k). Treasurer Wayne Swan has used these figures to affirm the success of 2010 reforms which banned exit fees. o Whilst refinancing is increasing, it has yet to reach the pre-GFC levels of 230k in early 2007. Moreover the refinancing is not seeing customers leaving the major banks, as smaller banks struggle to compete due to wholesale funding and non-bank financiers having departed to market during the GFC. BoQ, hit by bad economic conditions in SE QLD and discovery it overcharged customers $10m on loans, will become the 1st Australian bank to post a full-year loss in 20 years (ANZ's $575m loss in 1991-92 during "the recession we had to have") o The better news for BoQ is that H2 is trending up and will deliver NPAT $70-$75m after H1 loss of $90.6m. Other industries Woolworths advanced plans to demerge its $1.4B property portfolio to focus on retail. This will replenish Woolworths balance sheet by about $850m if a capital reduction if a capital reduction is approved at the groups Nov AGM and the equity raising goes ahead. o The spin-off 'Shopping Centres Australasia (SCA) Property Group' will take 69 shopping centres (new hardware chain 'Masters' have been excluded from the deal until the business becomes better established.) and become a new real estate investment trust listed on the ASX. Analysts predict that Woolworths would be able to use the capital generated from the deal to help roll out their Masters stores to compete with the successful Bunnings and Mitre 10 chains. A plan proposed by the Australian Customs and Border Protection Service to impose a tariff of up to 15.45% on imported steel to help BlueScope Steel against foreign competition has sparked opposition from businesses warnings of price spikes, including for new buildings, consumer goods and manufactured components. o In a twist it is the subsidised Auto industry that argues the tariff would hurt them as the steel they need is not available locally: in any case, symptomatic of a manufacturing crisis Macro Economy, Politics and Regulation The RBA cut its cash rate by 25 bps to 3.25%, citing weaker outlook for global growth and falling commodity prices o Banks have only passed on about 100bps of the 150bps cut by the RBA since Nov 2011. The RBA has indicated it is now taking credit pricing (i.e. banks propensity to move their rates) into account when making its decisions. RBA is considering the merits of introducing a fee on banks for taxpayer guarantees on deposits. A fee of 0.05% would collect $287m a year ($37.8 billion over 25 years) and rise deposit growth. o This is illustrating the trend that central banks are becoming activist in their role. The RBA also points out that 90% of taxpayer deposit insurance schemes around the world are funded through fees on banks, including Canada, US, UK and NZ. Treasury and RBA disagree on this: The RBA cautions against the 'moral hazard' of an uncapped guarantee and prefers a fee, whilst Treasury initially proposed an unlimited guarantee (more political). Residential building approvals rose 6.4% in August after a steep fall in July. However, even with the observed jump in multi-residential units, overall approvals are down 15.4% compared with same period last year: still low in recent historic terms, reinforced by new home sales at 15 year lows. o Effect of the RBA rate cut to been seen on the housing market - detailed update next week Retail sales grew marginally by 0.2% in August, advancing at half the pace predicted by economists. The figure compares with a 0.8% reduction in July. However, online retail sales grew 22% yoy, as reported by the NAB Online Retail Sales Index: the amount of $11.9B is equivalent to 5.4% of spending in traditional bricks & mortar establishments o These weaker than expected sales figures have contributed to market expectations of a further rate RBA rate cut in Nov. Adding to those soft numbers, Australias Trade Deficit rose to $2.03B in Aug ($1.53B in Jul), largest level since Mar-2008

Snapshots of the week: Have we reached 'Peak Car'*? (*: in reference to the better known 'Peak Oil') Despite a recent spike, motor vehicle sales in Australia seem to indicate a plateau... 1 - A recent improvement in vehicle sales should not mask the systematic underperformance since the peak reached in Jan 2008 Monthly Motor Vehicle Sales compared to January 2008 2 - Besides, it is foreign manufacturers that are benefiting

Source ABS - ABC, Greg Jericho

Source: AFR

3 - in fact whilst sales have now caught up with Jan 2008 levels, they are still well behind the 2000-2008 trend Total Monthly Sales of New Motor Vehicles (Trend)

4 - SUVs are the winners of the post GFC period Monthly Sale of SUVs (Trend)

Source ABS - ABC, Greg Jericho

Source ABS - ABC, Greg Jericho

September 2012 saw a record of 94,627 car sales in Australia, which seems contradictory to reports that the Australian car industry is struggling and lobbying for subsidies. Indeed, this increase should not mask the nature of the crisis affecting the Australian car industry: Firstly, the recent growth has actually been benefiting foreign car manufacturers. o Indeed, the top 5 in September were Toyota (Aus based) 17,300 sales; Mazda (imported) 10,093; Holden (Aus based) 8,955; Hyundai (imported) 7,815; Ford (Aus based) 7,764 ... and anecdotally 2 Rolls-Royces and 1 Saab (Saab Sweden filed for bankruptcy in Dec 2011) o This means that for the second month in 2012, a foreign importer Mazda outsold local car maker General Motors Holden. Having averaged 8651 sales per month so far in 2012, Mazda now needs to average 7379 sales across October, November and December to break the psychological threshold of 100,000 sales for the year. Another insight comes from looking at longer term trends, as suggested by ABC's columnist Greg Jericho: o Taking Jan 2008 as a reference, it is only the 4th month that more cars have been sold than during that high peak before the GFC slowdown. Despite the increase of recent months, the long term trend of monthly sales shows that to date the crisis took the industry back 4 to 5 years. Finally SUVs are the real winners of the post GFC dip with monthly sales above the 200-2008 trend, prompting comments that the motor vehicle sector is also a 2-speed economy. The hypothesis for this slowdown in car sales (2nd largest asset most people will ever buy after their home) is strongly correlated with the well documented increase in households' savings, if not debt deleveraging. The spike of SUVs can be partly explained by their popularity, but is also a clear sign that the more affluent demographics (esp. in WA + QLD) are 'doing well' whilst others are tightening their belts (the 2 speed economy) However, is this pattern purely due to the GFC? Or could it be a longer term trend indicating that we might have reached 'peak car'?... By different measures, the long term global trend is a saturation in 'motorized travel activity' 5 - Kilometres driven in passenger vehicles have either hit a ceiling 6 - Even the BRIC countries - economic power house of growth for the or started to decline globally automotive industry through the last decade - are reaching inflection point Average km travelled by car, '000 Passenger car sales in BRIC

Source: The Economist

A telling insight is that the decline in average car km in developed countries is not due to the GFC, but a much longer term trend. Source: Deloitte, Driving Through BRIC Markets Even in the BRIC countries sales are slowing as tax incentives that were introduced to provide the fillip for the automotive industry to meet the recession are being rolled back. India and Brazil have also tightened credit markets by increasing lending rates to contain inflation.

 Only Russia sustained a high growth rate in 2011 because of the continuation of government incentives to the auto sector. However, growth levels of 2011 is unlikely to keep pace in the upcoming years as the Russian market is also likely to feel the effect of rollback of incentives by 2013. The cars previously inexorable rise is stalling. A growing body of academics cite the possibility that both car ownership and vehicle-kilometres driven may be reaching saturation in developed countries - or even be on the wane, a notion known as peak car. Whilst the recession and high fuel prices have markedly cut distances driven in many countries since 2008, more profound and longer-run changes underlie recent trends. There are different measures of saturation: total distance driven, distance per driver and total trips made. The statistics are striking on each of these counts - even in America, still the most car-addicted country in the world. There isn't a single explanation but a combination of factors: o The number of trips has fallen, mostly because of a decline in commuting (possibly cyclical) and physical shopping (structural because replaced by online: 1/6 of Britains retail spending now takes place online.) o In the developed world younger generations are getting their licences later than they used to. Young people now prefer to move around more and settle down later. Even in Germany, where car-culture is strong the share of young households without cars increased from 20% to 28% between 1998 and 2008. o This means that young people drive less far and less often: for instance, 16 to 34-year-olds in American households with incomes over $70,000 increased their public-transport use by 100% from 2001 to 2009. o Cost is one factor: despite the increased affordability of cars (in 1995 it took 40 weeks of average wage to afford a Ford Falcon, 30 weeks in 2012), fuel prices have risen for all; and insurance premiums have tended to increase for young drivers. o The urbanisation of the world is another important factor. In most developed countries car use has been stable or increasing in rural areas, where driving still offers convenience. It is in cities that car ownership and use is declining, slowly substituted by alternatives such as public mass-transit systems (bus, trains) and car-sharing. And city living is on the rise: the OECD expects that by 2050, 86% of the rich worlds population will live in urban areas, up from 77% in 2010. Motorized travel activity 19702007/08 expressed a distance driven in cars and light trucks 7 - A telling measure is that growth in road travel is occurring at a lower proportion of GDP growth The levelling out or saturation of total passenger travel since the early years of the 21st century has occurred at a level of GDP between $25,000 and $30,000 in most countries, and in the U.S. at a slightly higher income of about $37,000. Research in those 8 industrialised countries estimates that the peak happened in 2003: and travel in private vehicles has declined. Even if car ownership has continued to rise, these cars are being driven less.
Source: Are We Reaching Peak Travel? Trends in Passenger Transport in Eight Industrialized Countries - Adam MillardBalla; Lee Schipper, Stanford University, U.C. Berkeley

8 - In the extremely long term, Vehicle Kilometres Travelled (VKT) per person has followed a traditional S-shaped adoption curve and is now plateau-ing Australian trend in vehicle kilometres travelled per person

If car use has peaked, what are the implications? If the trend is confirmed, car-makers will not find new markets in the developed world and will have to focus on replacement rather than growth. The most techno-utopians argue that a disruptive response Projection from carmakers will address the trend that "people are less interested in driving" and engineer cars that will require less driving from them: Driverless cars guided by robots could go on sale within the next decade, and might meet the mood of the moment and prove a profitable innovation. It will also have consequences on urban planning and government budgets, which will lose revenue on parking fees, fines, road tolls and Taxes from fuel, which for instance in the EU account for 1.4% of GDP. This tax revenue is already falling because of efficient cars and could plummet further if car use Dept of Infrastructure and Transport - Traffic Growth: Modelling a Global Phenomenon keeps dropping. On the other hand, governments will gain from public transport, car-sharing schemes, as well as from decrease in congestion: one lane of a freeway can transport 2,500 people per hour by car, versus 5,000 in a bus and 50,000 in a train, says research from Curtin University in Australia. To be clear, this memo is not arguing that car usage is going to vanish overnight, but that growth of the sector as we know it has reached a plateau. So whilst car insurance is still a profitable sector, the pressure to prepare for disruptive changes is increasing: The straight flattening of volumes as detailed above would have an immediate impact. A compound effect might also come from the spread of new technologies that would make driving "too safe to insure": such as telematics, collision avoidance, automated traffic law enforcement and robot-cars. If all of these 4 technologies are utilized to their fullest extent and encouraged by legislation, research firm Celent- Oliver Wyman predicts a sharp decline in accidents and, consequently, insurance premiums for liability and physical damage are estimated to drop 20-30% from 2013 to 2017 respectively, and between 60-80% from 2018 to 2022. Probably an unlikely aggressive scenario, but certainly a warning for what might come.