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Corporate Strategy Weekly Radar Update

Week ending Friday 30 November 2012 (snapshot: Rating Agencies + Ricky Ponting)

Highlights and Insights Financial Services IAG confirmed it is in "preliminary discussions with other parties to potentially offload its UK division (incl. specialist motor underwriter Equity Red Star): potential buyers could include QBE and even former IAG UK boss Neil Utley (this would include private equity). o However no agreement has been reached. The division is such a drag (modest returns, claims inflations, facing stiff competition, $297m writedown against the units carrying value earlier in 2012) that shareholders would welcome a sale "to close the chapter", even at a discount to net tangible asset value ($200m) IAG appointed Alison Deans, former boss of eBay Australia, as nonexecutive director. o Ms Deans appointment is an attempt to inject some digital thinking into IAG, especially after they discontinued online Buzz insurance brand earlier this year, which at the time was compared by with Suncorps ongoing commitment to Bingle as a strategic move to compete with online challenger brands. ANZ Wealth Management Chief Joyce Phillips presented their longawaited strategy, and highlighted a planned partnership with Swiss private bank Vontobel who is looking to improve its footprint in Asia Pacific. It was critically received, with analysts commenting it was light on detail (no specific goals or metrics). o Wealth Management is lagging at ANZ with 6.8% of group profit compared to 9.9% at Westpac, 9.3% at CBA, and 7.6% at NAB. The problem to solve is the complexity of the business: One Path inherited from ING is now fully owned but still not integrated in the brand. It also loaded ANZ's balance sheet with goodwill negatively impacting ROE. Phillips wants to double the number of financial planners to 600 over the next 2 years, accompanying the trend of increased salaried planners favoured by FOFA. The strategic options are to go for a broad client base (which the launch of ANZ Smart Choice Super could indicate), or on the contrary to focus on wealthy customers. On the positive, ANZ's strength is in Life insurance which lifted in-force premiums and ROE in the past year. Embedded value rose 22% in the past 2 years BEN is purchasing Southern Finance Groups loan book, equipment finance assets and financial planning business worth $290M. Due diligence and approval are expected by December. o Southern Finance are not an APRA regulated entity, and funding it provides is through unsecured notes. Following the recent collapse of Banksia, other non-banks could follow Southern Finance and reconsider their structure, strategy and future. Tower NZ announced FY12 results; Group profit of $56M (+67% yoy); GI PAT $13M ($3M FY11); GWP +20% yoy, marking a recovery from last year marked by the Christchurch earthquakes and reduced revenue from investments. o Analysts identified key the General Insurance result as a key upside (successful book repricing, 60% of earthquake claims closed) coinciding with a capital return to shareholders of $120M following the recent divestment of its health business sold to NIB for AUD81.3M. Citi upgraded the stock from Sell to Neutral; however still speculated that the GI business could be targeted by other NZ underwriters. Listed insurance broking group Austbrokers held its AGM and confirmed positive outlook for FY13 of NPAT growth of between 510% and reiterated belief that industry consolidation is likely to continue in the near to medium term, presenting further acquisition opportunities. They reported a 20% rise in net profit from $21.4M to $25.6M for the year to June. Revenue climbed from $114.29M to $125.43M during the same period. Other industries QANTAS ended its 40 year sponsor relationship with Tourism Australia (TA). TA chair Geoff Dixon, ex-CEO of QANTAS recently publicly questioned Qantas CEO Joyces strategy, and is also part of a consortium which has acquired 1.5% stake in the airline and is agitating for change. o The biggest winners from the dispute will be the state tourism bodies, whom QANTAS have announced will receive the $44M of funding. Virgin is in talks with TA to increase its sponsorship and capitalise on the dispute. Macro Economy, Politics and Regulation A number of comments were made on Australias Superannuation system - 1) Conservative think-tank Centre for Independent Studies questioned whether compulsory superannuation remained the most effect way of promoting national retirement saving and reducing consequential budgetary demands; 2) JPMorgan Exec Benjie Fraser highlighted that the present system was well placed to deal with issues faced by international pension systems participation, security and adequacy; and 3) Ex-PM Paul Keating repeated calls for the rising of the rate to 15%. o The debate highlights both philosophical (CIS describes the system as paternalistic) and practical questions as to the systems future after 20 years of existence. The increased life expectancy and living standards of Australians over when the scheme was introduced in 1992 has raised questions of adequacy, and the fact that wage inflation is not as drastic a problem (its control a key policy rationale at the time) raises questions as to whether there are more appropriate measures of promoting national savings. The Bank of Russia has begun to stockpile A$ as a reserve currency, with 1% of its reserves and plans to rise to 5-10% o The increased demand of A$ by economies such as Russia, the likelihood of further QE in the US and continued weak global growth is likely to keep upward pressure on the A$. This can be evidenced by the dollar being higher now than in Oct 2011, during which the RBA has cut official rates by 1.5% Governor of the Bank of Canada Mark Carney will become governor of the Bank of England from July 2013 for 5 years o Some analysts predict Carney will introduce increased emphasis on leverage ratios (complementing present riskweighted metrics) within capital management requirements of British banks. Greece agreed to a plan to lower its debt to 124% of GDP by 2020 in return for 44B in loan payments. o The IMF identified 120% as the maximum level Greece will have to reach by 2020 to return be able to sustainable and independently returns to economic health. However, commentators note that only a growing economy can remain solvent at that level, which remains questionable given the Greek economy has shrunk each year since 2007. US Fiscal Cliff: Democrats and Republicans remain at an impasse, with Republican Speaker John Boehner again rejecting President Obamas plan to increase taxes on income earners over $250,000 (top 2% of income earners) unless Medicare and Social Security benefits are cut. o Some Republicans are now calling on their party leadership to agree to the Presidents plan given its widespread public appeal, and with it also being a down payment on a comprehensive tax and entitlement reform deal to be negotiated in 2013.

Snapshots of the week: A primer on Credit Rating Agencies Why rate and where to get it? The Rating Agencies business started in 1909 when John Moody became the first financial analyst to assign letter grades to railroad bonds, giving investors an easier way to evaluate the rail companies' debt. Poor's Publishing (later Standard & Poor's) started selling its bond ratings to investors in 1916; Fitch followed suit in 1924. However in Finance, when something exists, it is often either an innovation to hedge the market,... or a regulation as a response to a crisis: Debt Rating really rose to prominence in the US in 1936 as part of the New Deals reform of Americas financial markets. Regulators forbid banks and institutional money managers to buy securities deemed speculative by recognized rating manuals. Insurance companies, pension funds and mutual funds subject to public regulation are required to take into account the views of the credit ratings agencies, provided them with a government-sanctioned monopoly. The sector is dominated by those 3 major agencies who offer their opinions (without being legally liable) as to the payment prospects of various grades of security via a "grade" - from AAA (as secure government debt, the top rating because governments always can print the money to pay) down to lower "junk" - and an outlook: for S&P's assessing the potential direction in which a rating will move over the next 6 months to 2 years: positive, negative, stable, or developing (meaning its uncertain whether a rating might go up or down) Although seen as quite homogeneous, the 3 major US Agencies approach ratings in 2 different ways S&P focuses on the Probability of Default (PD). S&P gives the definition of a Rating as "an opinion about the ability and willingness of an issuer (corporation, government) to meet its financial obligations and the relative likelihood that it may default." Moodys focuses on Loss Given Default (LGD): the credit loss incurred if an obligor of the bank defaults. Moody's states that "the foundation of Moody's rating approach rests on the answer to one question: What is the level of risk associated with receiving full and timely payment of principal and interest on this specific debt obligation and how does that risk compare with that of all other debt obligations?" They measure the ability of an issuer to generate cash in the future. Fitch focuses on the Probability of Default stating that Credit ratings, as opinions on relative ranking of vulnerability to default, Credit ratings are opinions on relative credit quality and not a predictive measure of specific default probability" Ratings apply to Long term as well as short term. Rated instruments are considered more liquid Most banks use all three agencies to provide diversity of opinion. There are geographic preferences: e.g. US Commercial Paper (USCP) investors prefer a Fitch rating whilst Sources: European investors tend to prefer Moodys. http://fic.wharton.upenn.edu/fic/papers/04/0401.pdf http://www.standardandpoors.com/aboutcreditratings/Ratings SUN uses the three of them, but will select only two agencies for RMBS/covered bonds. Manual_PrintGuide.html For example. S&P have not yet rated any Australian covered bond program due to Sam Miller, SUN Investor Relations: 'Credit Ratings Overview' limitation in rating methodology for covered bonds. However the model has increasingly been challenged since the GFC - for various reasons Court cases and regulation in the West Until now rating agencies have been operating under the assumption that in the US they are protected by the constitutional right to free speech: their ratings are just an opinion and therefore not subject to complaint - also covering eventual issues with "the usual fine-print disclaimers" In Australia: The Australian Federal Court has delivered a landmark first instance judgment which holds a credit rating agency liable for the first time (among other things) for the negligent AAA rating of a structured financial product: In Bathurst Regional Council v Local Government Financial Services & Ors [2012], the court held that 13 local councils were entitled to be compensated for their estimated A$30m losses arising out of their investment in Rembrandt notes that lost more than 90% of their value during the GFC, comprising constant proportion debt obligations (CPDOs) arranged by ABN Amro, rated AAA by S&P, and marketed and sold to them by the financial advisory business, Local Government Financial Services (LGFS). (S&P is appealing) The decision comes almost 6 years after the onset of the credit crisis, which coincides with the expiry of the limitation period which typically applies to claims in negligence. As a consequence, it is likely the decision will set a precedent for similar claims in Australia and elsewhere. In Europe: The EU is drafting plans to limit the industrys influence and tackle conflicts of interest. Investors will also get the right to sue ratings companies if they lose money because of malpractice or gross negligence. The regulation will also limit "Unsolicited Assessments" (when not paid by clients) on sovereign debt ratings to "three days a year" and will have to "justify the timing of publication" Geo-political competition at play... from China: ... enter the Dagong! (the map shows a clear East vs West "differences of opinions")

S&P, Moody's and Fitch control more than 90% of the international credit rating market - a dominance that is beginning to irk Beijing. China's central bank governor Zhou Xiaochuan has been warning Chinese companies to rely less on the credit assessments of the 3 majors and to do more of their own due diligence. And China is clearly giving itself the tools to back the rhetoric: Dagong is one of the few non-US agencies and made headlines in 2010 when it published its inaugural report on global sovereign debt risks, a first by a non-Western ratings agency: the most controversial item was its assessment of the US debt as riskier than China's. For what it's worth, Dagong rated Australia with a coveted AAA, which made it four out of four across all agencies. Dagong is also about up the ante: In October 2012, it announced plans to form a joint venture Universal Credit Rating Group with Russian agency RusRating and Egan-Jones Rating, the 4th largest US ratings group: the political bias is obvious given CEO Guan is a Communist Party member with close ties to the Chinese leadership. However it is a Realpolitikal wedge that the EU welcomes given its discontent with the incumbent majors.

And because this is an Aussie radar, by popular demand, this is to salute cricketer Ricky Ponting's retirement... Ricky Ponting Test Career Batting Performance: yes, there have been rightful questions about his opportune time to retire... There is no doubt Ricky Ponting is in the pantheon of Australian cricketers. He is amongst the very greatest, and the last great player from the Waugh/ Warne/ McGrath/ Gilchrist era when Australia was the indisputable champion of the world in all formats.
19951999: Early International career 19992002: The road back to the Australian side 20022004: 20042008: One Day Test captain International captain 20082011: 20112012: Test Captain PostDecline captaincy in form

However, it can be clearly seen on his graph above that he has been in decline for a number of years. The start of which seems to coincide with the retirement of Shane Warne and Glen McGrath. in 2007 This "decline in form" triggered a significant amount of commentaries and speculations throughout the end of his career: to put it plainly: when to retire before it's too late? It was argued at the time that while his average was deteriorating, Ponting stayed because there was no one to take his place as captain. Indeed, back in Dec 2010 his last 15 innings were: o Ricky Ponting: Average 29.6; Nil 100s; five 50s; top score 77. When comparing with the last 15 innings of other players who had been given the push: o Matthew Hayden - Average 26.4, Nil 100s, 2 50s, top score 83. o Greg Blewitt - Average 30.9; Nil 100s; two 50s; top score 89. o Darren Lehmann - Average 28.6; Nil 100s; five 50s, top score 70. o Michael Slater - Average 39.8; Nil 100s; three 50s, top score 86. o Mark Waugh - Average 33.7; Nil 100s; two 50s, top score 86. Two players who jumped before the push: o Justin Langer - Average 33.6; one 100; one 50; top score 100*. o Adam Gilchrist: Average 35.2; one 100; four 50s; top score 102* And two players who were a bit above the average: o Greg Chappell - Average 52.3, three 100s, two 50s, top score 182. o Steve Waugh - Average 53.2, two 100s, three 50s, top score 115. (minus two matches against Zimbabwe and Bangladesh) This stats really confirmed that his average was below than all the above bar Hayden and Lehmann - his retirement at almost 38 (next month) shows that thanks to a host of reasons (personal will, and the system allowing him to carry on) he really was able to stretch it to its maximum.
Source: ABC's polymath researcher, columnist and panellist Greg Jericho http://grogsgamut.blogspot.com.au/2010/12/cmon-punter-put-your-hand-up-and-go.html

... however, on the other hand, looking at Ponting stats also confirms he truly belongs to the greatest. Since 1877, each era has featured these out-and-out champions, starting with Billy Murdoch, the first man to make a Test double-century and the first Australian to score a Test century in England at a time when the English believed, with some justification, that Australians were top bowlers and fielders but couldn't bat. The Golden Age had the twosome of Clem Hill and Victor Trumper; bracketing the war was the career of the ''Governor-General'', Charlie Macartney; then there was Don Bradman spanning two decades; in the post-war era was Neil Harvey, before the mantle was passed to Greg Chappell, then Allan Border, Steve Waugh and Ponting. Only the '60s, which prospered under a committee of Bob Simpson, Bill Lawry, Ian Chappell and Doug Walters, lacked this singular batting master. Looking at the stats certainly puts Ponting in this group, with the significant limitation that cricketers of one generation cannot be fairly compared with those of another: conditions and bowling attacks are too dissimilar. An interesting stat is the "% excess" which indicates batsmen's Test average compared with Australia's overall batting average in their era. This gives a fair idea of how difficult it was to score runs. o Harvey, for instance, averaged 48.41 in a tough time for batsmen, with England and the West Indies both boasting potent pace and spin attacks. o Australia's prevailing batting average was only 33.71 in Harvey's time, against which his average was 43.6% higher. Ponting's is 31.9% higher than his contemporaries at a time of increase professionalization of sports and probably difficulty to leave the others behind. In fact you have to go back to the 1970s-80s to find the only two Australian batsmen outside Bradman who have exceeded their contemporaries more than Murdoch: they are Border and Greg Chappell. Both played against the mighty West Indian pace attack of the 1970s-1990s: Greg Chappell's average of 54.42 was twice that of his team. Only one Australian batsman has ever got near that kind of performance: Don Bradman averaged a surreal 154.7% more than his contemporaries. To get a sense of the extra terrestrial nature of this record, Sachin Tendulkar's average is 49.1% better than India's in his era, and Brian Lara's was a mighty 77.7% in excess of the West Indians of his. Finally adding to his Test career, Ponting will be remembered an outstanding One Day International cricketer too: Leading his country to 2 World Cup wins, he is Australias highest impact ODI captain in its history. And the 3rd-highest impact captain in all of ODI history after Clive Lloyd and Hansie Cronje.