Rebalancing the UK Economy (While Wealth Shifts East) Pete Hahn Foundation for Management Education Fellow Corporate Finance, Governance & Banking July 2008

Disclaimer The Presenter, Sources, Opinions…….

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

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

Major UK Banks Net Interest Margin Basic banking has been getting less profitable for 10 years!

UK Banks Lending to Non-Financial Corporations Very Stable Growth

UK Banks Aggregate Balance Sheet (End 2007)

UK Banks Write-Off Rates

Financial Market Liquidity (a)

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

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.

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.

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

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

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.

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.

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’.

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’.

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.

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.

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.

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.

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.

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.

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 .

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 .

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.

(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.

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 ?

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 ?

Thank You & Remember: The Economy Will Improve

Thank You

&

Remember:

The Economy Will Improve