Key Characteristics. Product Type Bonds Last Price $ Fixed/Floating Floating Running Yield** [ %] Quarterly. Current Distribution**

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1 Issuer Name Australian Unity Limited Security Name Australian Unity Bonds Key Characteristics Product Type Bonds Last Price $ Issue Size* [$200,000,000] Accrued - Par Value $ Capital Price $ Fixed/Floating Floating Running Yield** [ %] Payment Frequency Quarterly Yield to Maturity*** [ %] Security Recommendation Subscribe Security Risk Upper Medium Current Distribution** Issue Margin/ Coupon** Franking Credits Inclusive ASX Listed [ %] Trading Margin - [ %] Optional Call Date N/A No Yes (Prospective ASX Code: AYUHB) Legal Final Maturity Next Ex-Date - 15 December 2020 (5 Year) Issuer Outlook Convertible No Next Payment Date [April 2016] Improving Stable Deteriorating GICS Sector Insurance Next Cash Distribution**** [$ ] * Size is subject to change. The issuer has guided to a size of $200 million. ** Based on a prospective issue margin of [ %] and 90-Day BBSW of 2.19%. Actual margin to be set at bookbuild. *** Based on a prospective issue margin of [ %] and interpolated swap rate to maturity of 2.46%. Actual margin to be set at bookbuild. **** Actual cash amount based on $100 face value. Summary On 9 November 2015 Australian Unity Limited (ASX Code: AYU) announced a new issue, Australian Unity Bonds - Series B (Prospective ASX Code: AYUHB). The size of the offer is indicated at $200 million but will change based on demand. The purpose of this transaction is to help fund the acquisition of Home Care Service NSW and help refinance the existing Australian Unity Notes (ASX Code: AYUHA). The issuer (Australian Unity Limited) is a non-operating holding company and the majority of its assets are investments in subsidiaries of the Australian Unity Group. Most of the claims AYU has on each of its operating subsidiaries rank behind the operating company s creditors. Therefore the issuer is a slightly higher risk than its regulated subsidiaries. The bonds are structured as simple corporate bonds meaning they have no optionality and interest payments are mandatory. To qualify as a simple corporate bond this security has met specific legal eligibility requirements on the issuer and the security. The bonds are protected by event of default conditions which give the holder the right to recover any unpaid principal or interest subject to issuer solvency. Australian Executor Trustees Limited has been appointed as the trustee for holders of the bonds and they will act on behalf of the holders to enforce Australian Unity s obligations to pay interest and principal in a full and timely manner. The bonds pay a floating interest rate of 90-Day BBSW plus a margin (to be set at bookbuild but guided at [ %]) payable quarterly in arrears on 14 January, 14 April, 14 July and 14 October each year. The bond may only be redeemed on its legal final maturity date (15 December 2020) or when a Tax Event, Change of Control Event or a Clean Up Condition exists. Bond holders are protected by a series of covenants such as a negative pledge, restrictions of indebtedness and gearing covenants. Figure 1: Capital Structure 1 Figure 2: Relative Value 2 High Risk Low Risk 1.5% 14.4% 43.8% 3.0% 10.5% 2.8% 3.1% 2.8% 4.9% 0.7% 12.5% Tax liabilities Deposits Health Insurance Policy liabilities Refundable Accomodation Deposits Resident Loan Loabilities Unearned Premium Liability Senior Secured Senior Unsecured Other liabilities Tier 2 Regulated Capital Common Equity Yield to Maturity 2.25% 0.75% ME Bank Wholesale Sub Notes, 2.94% SUNPD, 2.64% Generic 3 Year, 2.36% Bendigo Wholesale Sub Notes, 2.61% AMPHA, 2.34% Australian Unity Bonds, 2.80% Generic 5 Year, 2.40% Term to Maturity (Years) Generic 7 Year, 2.54% Generic 10 Year, 2.51% 9 November 2015 Page 1 of 5

2 Security Recommendation - Subscribe This is the second bond/note issued by Australian Unity Limited to be listed on the ASX. The initial notes (ASX Code: AYUHA) were issued in 2011 to diversify the groups funding sources and repay short term debt. Since then the group has embarked on a period of transformation from a group which specialises in Private Health Insurance (PHI) to a diversified conglomerate with non-correlated earnings streams but remaining small enough to specialise in a particular demographic. In our opinion the overall credit risk of the issuer is broadly neutral since the last issue as gearing has increased slightly (net debt remains negligent) but the diversification of earnings streams has improved. We acknowledge that the gearing covenant has deteriorated slightly since last issue (was 45% now 50%) but this is a result of an acquisition (Home Care NSW) which should fit soundly within the existing business and be cashflow accretive from an early stage. For this reason we expect the performance of this bond to be stable and broadly in line with AYUHA. Australian Unity Bonds (Series B) have similar credit and structural risks to its predecessor but as a simple corporate bond it is vastly different in structural terms to hybrid securities. AYUHB contains a covenant protection package for bondholders to protect them from losses including a negative pledge, financial gearing covenant on the issuer and restrictions on subsidiary indebtedness. Therefore, the risks relevant to this security are consistent with the previous issue. The key risk being the subsidiaries remain well capitalised (i.e. restriction on dividend upstreaming from Australian Unity Health) and do not take on excess debt to fund growth. From a valuation perspective this security is difficult to inherently value due to a lack of comparable securities making any relative value analysis difficult. From a broad industry perspective its closest comparable issuers are AMP, Bendigo, ME Bank and Suncorp but these are financial issuers with business and operating risk profiles. Using generic data provided by the RBA on comparable issuers AYUHB looks attractive but that data is a stretch to be truly comparable. In our opinion AYUHA offers defensive exposure to the regulated private health insurance and aged care market. It is priced at a margin that is considered fair and commensurate for the risk and therefore we recommend investors Subscribe. Positive/Negative Risk Factors Strengths: The competitive position of Australian Unity Health could improve materially depending on the outcome of a review recently announced by the Health Minister. Recent acquisitions (including Premium Wealth Management, Flinders Australia limited, Home Services NSW and Waratah Insurance Brokers) should complement the existing business segments and provide scope to expand in line with group strategy; The covenant package (including gearing ratio, subsidiary financial indebtedness and a negative pledge) is a strong protection to bondholders due to the ability to enforce proceedings against the issuer (via the trustee) if covenants are breached or payments are missed; Robust and competitive health insurance arm that generates over 53% of adjusted EBITDA Conservative risk appetite with regard to net debt and maintenance of buffers above regulatory capital requirements From 1 July 2015 responsibility for the prudential supervision of private health insurers transferred from the Private Health Insurance Administration Council (PHIAC) to the Australian Prudential Regulation Authority (APRA). Increasing diversification benefits of continued expansion into Retirement Living, Financial Services and Big Sky Building Society businesses. Weaknesses: The Future of Financial Advice (FoFA) and MySuper reforms are setting challenging tasks for the personal financial services segments. The uncertainty surrounding these regulatory changes are still under debate by industry stakeholders but the compliance burden is likely to be felt by consumers as the cost is passed on; The reform package introduced on behalf of the retail life insurance industry as a result of the Life Insurance Industry Inquiry will lead to changes in the way advisers are incentivised and reduce many conflicts of interest. This is likely to have some earnings impact on the issuer; The relatively modest size of the insurance operations and concentrated customer base (relative to the market s largest insurers) means the high cost of acquisition will make it difficult to increase policyholder numbers; A deterioration in Australian Unity Health s operating performance due to increased competition, lower margins or other changes will put negative pressure on the risk rating of the issuer. This is also true if retirement living and banking were to adversely affect the group credit risk. The adjusted gearing ratio covenant has been creeping from 45% to 50% from Series A to Series B. There is a risk the acquisition of Home Care NSW will not proceed due to the default of a party or a failure to meet a condition precedent to completion by either the New South Wales Government or Australian Unity, even though a binding contract exists. Exposure to project and construction risks inherent in property development. Restricted financial flexibility, given Australian Unity Limited s mutual status precludes future equity raising. 9 November 2015 Page 2 of 5

3 Issuer Outlook - Stable Earnings Australian Unity is one of Australia s oldest mutuals and has a long history of providing professional services to its members. They are most commonly recognised as a provider of Health Insurance to Australian consumers and this is evident in their earnings profile as the Healthcare business (which includes insurance and the delivery of health services) dominates earnings for the group (representing 53% of group EBITDA) through the regulated subsidiary Australian Unity Health Ltd ( AUH ). Group EBITDA has been growing steadily over the past 5 years primarily as a result of stable earnings from AUH and growth within the Retirement Living segment. The revenue drivers for AUH remain the supportive government policies which attract and retain younger members and a regulatory system which supports the funds. Our analysis suggests that as at 30 June 2015 the proportion of the Australian population with private health insurance coverage was 55.9% and the private health sector funded over 4.12 million hospital episodes each year. However, the stability in customer volume (and growth) is offset by restrictions on the ability to set prices and changes to means testing of the PHI rebate and the Medicare Levy Surcharge. These drivers will support earnings for AUH into the future but are partially mitigated by rising acquisition costs and churning within the industry which could benefit the For Profit health insurers at the expense of Members Owned funds such as AUH. Retirement Living is key segment of growth for the group (in 2015 revenue increased 19.7% to $106.8 mn and adjusted EBITDA up 12.2% to $23.9mn). As a provider of aged care facilities, home care services and independent living units the earnings projection is a function of the ageing demographics of the population and their requirements during the later phases of their life. Australian Unity is involved in construction and development of new retirement communities and expansion of its home care services. Occupancy rates are very high (97% in retirement villages and 98% in aged care facilities) and this is expected to continue into However, the real growth is coming from Home Care which provides government subsidised services in the home for people who are aged or have a disability. Revenue in this segment doubled in the past financial year as a result of winning government tenders in NSW and the acquisition of INS Healthcare and KNS Essential Care. This growth was confirmed in August 2015 when Australian Unity announced the execution of an agreement to transfer Home Care NSW as a discreet entity to become part of the Australian Unity Group. This service is currently run by the NSW government and provides care services to 50,000 clients across NSW. According to AUH this group has revenue of ~$230mn and under the transfer agreement, Australian Unity will buy Home Care NSW for $114 mn (subject to adjustments). The other business segments (Investments, Personal Financial Services) are meaningful contributors to the group and with the recent acquisitions of Premium Wealth Management, Flinders Australia and Waratah Insurance Brokers we expect earnings from these segments to grow. Capital Management As a mutual, Australian Unity must adopt different policies in regard to capital management as a private or listed entity due to the fact they do not have access to equity capital markets and capital is predominantly represented by Member Balances and Retained earnings. For this reason they are naturally risk averse and they cannot access capital markets to offset negative returns. They also do not pay dividends so all profits are reinvested as capital for the benefits of members. Debt plays an important role in the capital structure of the group but it is not the sole contributing factor to managing capital. Due to the regulated nature of the operating subsidiaries they are bound by capital adequacy requirements similar to other insurance companies. Australian Unity Health is the most capital intensive subsidiary of the group with a publicly stated surplus capital target of 1.35x the regulatory minimum. All surplus capital (that is retained earnings) gets distributed to Australia Unity Limited (the NOHC ). However, APRA has the supervisory power to restrict dividend payments to the NOHC should Australian Unity Health find itself in a stressed scenario and cannot maintain a minimum capital standard. Therefore, the capital buffer of the subsidiary is very important to servicing any debt of the NOHC. From a debt perspective the issuer s current obligations are the Australian Unity Notes ($120m) and the bridging facility to finance Home Care NSW. On a forward basis (that is post refinancing of the Notes and bridge facility) we expect gross debt of ~$220m (an increment of ~$100m). This will provide a pro-forma gearing ratio of ~40% (the reported gearing ratio was 33.7% as at 30 June 2015) well below the maximum gearing covenant of 50%. Although this measure is not a consolidated gross debt basis a significant amount of subsidiary financial liabilities are ringfenced and non-recourse to the group. On a consolidated net debt basis the group has effectively no liability due to the large amount of unrestricted cash (~$900m) at its disposal. Outlook The outlook for Australian Unity Limited is stable due to the naturally conservative company structure (mutual) operating in tightly regulated industries. The competitive position of the group varies between business segments and products but its Health and Retirement business underpin its solid operating performance. Over the past few years the group has transformed its overall operations to diversify away from the core operations but remained focused on products and services on a particular demographic. The Home Care NSW agreement could be a transformational for the group but given the significant amount of acquisitions over the past few years we do expect some operational issues. 9 November 2015 Page 3 of 5

4 Figure 3: Credit Curve (Upper Medium Security Risk) AYUHB, [ %] 2.50% 2.00% Trading Margin 1.00% Credit Risk Curve 0.50% 0.00% Source: BondAdviser Term to Maturity (Years) Figure 4: Historical Trading Margin of AYUH 5.00% 4.50% AYUHA 4.00% 3.50% Trading Margin 2.50% 2.00% 1.00% 0.50% 0.00% 19/04/11 19/08/11 19/12/11 19/04/12 19/08/12 19/12/12 19/04/13 19/08/13 19/12/13 19/04/14 19/ /12/14 19/04/15 19/08/15 1. The balance sheet structure diagram represents a measure of liabilities and capital in order of seniority of the overall cash balance sheet. 2. Pricing as at close of business 5 November Source: BondAdviser, RBA, Bloomberg 9 November 2015 Page 4 of 5

5 Analyst Nicholas Yaxley Credit Research About BondAdviser BondAdviser is an independent investment research company that specialises in bonds and fixed income securities. We provide investors, advisers, brokers and institutions with research, data, education and tools to help them invest intelligently. Our service is delivered online via an easy-to-use portal. BondAdviser has the broadest coverage of retail-accessible ASXlisted and over-the-counter securities, including primary and secondary issues. Our expert credit team draws on its extensive experience and robust research process to deliver unbiased insight backed by detailed analysis. At BondAdviser, our goal is to lift the lid on the fixed income market so that more investors have the opportunity to invest in the asset class directly. Learn more To learn more about the fixed income market visit our website Important Information Bond Adviser Pty Limited is authorised to provide general financial product advice under its Australian Financial Services Licence, with licence number , issued to it by the Australian Securities and Investments Commission. Some of the research in this report is based on past performance. Past performance is not an indicator of future performance. Bond Adviser has taken all reasonable steps to ensure that no conflicts of interest have influenced the contents of this research report. Bond Adviser has taken all reasonable steps to ensure that any opinion or recommendation in this report is based on reasonable grounds, and is not influenced by any interests of Bond Adviser staff or other persons. The data generated by the research in this report is based on methodology that has limitations; and some of the information in this report is based on information from third parties. Bond Adviser does not guarantee the accuracy, completeness or adequacy of the research, opinions, recommendations or content of this report. This report includes both positive and negative research and product ratings. The research in this report was not commissioned or funded by a third party service provider or product issuer. This report was created on 9 November Bond Adviser does not guarantee the currency of the research. If you would like to assess the currency, you should compare the contents of this report with more recent characteristics and performance of the assets mentioned within it. Investment can give rise to substantial risk and a product mentioned in this report may not be suitable to you. The content of this report is of general nature only, and does not amount to personal advice. It does not take into account your objectives, financial situation or individual needs. Bond Adviser recommends that, before making a decision based on the content of this report, you should consider your objectives, financial situation and needs, and seek independent financial or legal advice if necessary. Some of the information in this report is restricted to wholesale clients, as defined in Section 761G of the Corporations Act By using Bond Adviser s services, you agree to indemnify Bond Adviser, its associates and representatives against any loss, claim, damage or action suffered in the course of your use of the services. 9 November 2015 Page 5 of 5