Rebalancing the UK Economy (While Wealth Shifts East)

Pete Hahn

Foundation for Management Education FellowCorporate Finance, Governance & Banking

July 2008

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Disclaimer

The Presenter, Sources, Opinions…….

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Covering Today

• 3 Minute Overview of Banking

• Recessions – Why it’s a little different this time?

• Prospects & Inflation

• Who will be hurt the most?

• Economics & Business thoughts to help

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Major UK Banks Net Interest Margin

Basic banking has been getting

less profitable for 10 years!

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UK Banks Lending to Non-Financial Corporations

Very Stable

Growth

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UK Banks Aggregate Balance Sheet (End 2007)

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UK Banks Write-Off Rates

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Financial Market Liquidity (a)

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Moody’s Speculative Grade Bonds Default Rates and Expectations (a)

percent

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Where Do Recessions Come From?

Historically:– Usually caused by overinvestment in industry (excess supply)

– Poor interest rate policy (government mismanagement)

– This time it is excess credit expansion, asset bubbles, and global demand inflation (quite a bit different and harder to understand)

» To be blunt, we don’t understand it very well but it is starting to look like the 1960s and 1970s.

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Prospects

• Banks are going into a downturn and they are already weakened (with relatively low capital).

There’s plenty of money inside, but it’s mostly committed to existing loans.

Capital, or the petrol of the banking system, is near empty. It’s very

expensive, and investors want to put it elsewhere. Without new capital, credit

dries up.

Banks

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Prospects

• New, more rational credit standards have started to apply.

– Wrong time for the economy to apply tighter credit standards, but a necessity for the banks.

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Prospects

Inflation is a very ugly story. For those under 45 years of age who haven’t seen it before:

– Business Models weaken dramatically trying to adjust to higher costs (family finance, too).

– Investment Declines leading to reduced employment.

– Asset values change.

– Real wealth erodes, mostly affecting the ‘asset poor’.

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Who Will Be Hurt the Most?

• Low incomes and pensioners– The Hahn family’s monthly fuel bill rose from £60 to £87 per month from 1997-

2005 (5%p.a.) to a current £160 (23%p.a.). Food? Higher mortgage rates. The lower the income the greater percentage these costs are of the total. Real disposable income growth was replaced by borrowing for last few years.

• Service sector employment (& big parts of retail sector).

• Overextended and recent FTBs.

• More of your friends than you think.

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Who Will Be Hurt the Most?

– Manufacturers that don’t export.

– Small businesses that need investment to survive.

– Smaller banks and building societies may close.

• Businesses (and others) that depend on discretionary spending like you.

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Your Investments

• If you’re in the market, you might be surprised what you’ve got. The biggest chunk of the FTSE 100 (80-90% of the UK market) is now in commodities, ever heard of Kazakhmys?

– It is going to be volatile and is dependent on commodity prices

which may be in a bubble.

• Real estate is becoming less liquid, with lower values, and may soon produce lower rents and become less occupied.

– Cash will be king for a while. If you don’t mind having investments denominated in Euros (€), you can diversify more.

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How Long Will This Last?

The politicians say….Business leaders say….

But, it won’t be months.

Her Majesty’s Revenue & Customs is going to be squeezed.

In the end, fundamentals should be restored, but it could take a few years.

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Some Business & Strategy(and I don’t know charity law, restrictions, or the politics of the Charities

Commission)• Revisit your mission and focus on what you do best (a lesson

for banks today, too). You may have taken on too much.

• When money gets tighter, rethink where you can add the most value. Sometimes shrinking allows you to grow more effectively.

• Revisit your government funding for its economics.

• Have your costs truly been covered? Your cost structure changed?• Has your remit expanded faster than your funding?• Early on I learned that the number two cause of failure is success.

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Help Thyself

• Plan on a slow down in donations.

• Reinvent yourself. Modernise your message.

• Innovation is 95% repackaging.

• Diversify your funding fast.

• Are there any ‘for profit’ commercial activities you could undertake for additional funding? Your facilities? Your expertise?

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Thank You

&

Remember:

The Economy Will Improve