Danareksa Banking sector A letter from Singapore

A short trip to our neighboring country
We made a short 3-day trip to Singapore this week and met with 20 investors and fund managers to convey our bullish view on the banking sector. Most investors agree that the Indonesia economy is sound but see uncertainties in the political arena. They also share the same view that the Indonesian banking industry is expensive on a regional comparison but also see potential upside in some of the banks - in particular those that lend to the consumer sector where growth is still aplenty.

Slower loans growth and rising NPLs
These are the two main concerns raised by investors. Yes, amid the ongoing economic slowdown marked by higher risk aversion, we have seen loans growth slow to about 4% in 4Q08 from its peak of 10% in 2Q08. In fact, loans growth even turned negative in Jan-Feb 09 (compared to Dec 08). And a search for greater liquidity has also led to a higher cost of funds. As for NPLs, they rose to around 4.3% in Feb 09. Moreover, the NIM has declined to 7.5% in Jan-Feb 09. However, we still believe the banking sector has good prospects. Although banks are not lending as aggressively as they were last year, they should still be able to grow loans by 10-22% this year. We also believe the fears on NPLs are overdone. Note that the NPLs are still lower than the 5-year average of 6.7% and still way down from 2001’s 18%.

A turnaround in 2H09
We believe loans growth shall accelerate in 2H09E, supported by benign inflation of 6% by YE09 and a lower BI rate of 7.25%. In addition, the fiscal stimulus initiated by the government should help boost domestic consumption. Note that of the Rp73trn fiscal stimulus (1.4% of GDP), about Rp43trn is intended for tax incentives. We expect the impact from the stimulus to be felt in 2H09 with a rebound in domestic consumption. Consumption credit for SME has seen the highest growth in recent years (30% 6-yr CAGR), and we believe this will remain the case in the future. We expect industry loan growth to average about 10% this year, before picking up to about 15-20% next year.

Top picks: BBRI and BDMN
Our message is simple: a consumer recovery – helped by benign inflation and cuts in interest rates – will give banks the opportunity to channel more loans to the consumer segment this year. Moreover, they will be in a position to do this since they have strong balance sheets. We believe BBRI and BDMN should do well since more than 80% of their loans are channeled to the micro and consumer & micro segments. Lending rates in these segments tend to be high and sticky with a wide NIM at around 10-11%. Moreover, BDMN should benefit from declining interest rates since 70% of its deposits are costly in nature. On top of that, both BDMN and BBRI have a higher proportion of loans in comparison to their assets. This should cushion them from declining interest rates. We have BUY recommendations on both BBRI and BDMN. For BBRI, our TP is Rp6,300, implying 3.0-2.6x FY09-10E PBV, and for BDMN our TP is Rp3,600, implying 2.3-2.1x FY09-10E PBV.