Citigroup Indonesia Banks - Riding the Liquidity Wave

 Buy Mandiri, Sell Danamon, upgrade BRI to Hold, downgrade BCA to Sell —
Defying valuations, Indonesian banks continue to outperform in a global context, driven by expectations of a takeoff in credits, firm NIMs and an NPL downcycle.
Although we remain concerned about high valuations and risks to NIMs due to high LDRs, the immediate risk to earnings has diminished. BI remains dovish. An easy monetary policy benefits banks with high LDR (BBRI, BDMN) but hurts NIMs (BBCA, BMRI). Our calls on BBRI and BBCA are non-consensus. We have raised estimates and assign peak-cycle valuations of +1sd above average P/Es, increasing target prices by 9-28% for our Indonesian banks universe.

 Positive macro indicators — BI’s push for loans is driven by its assessment of excess capacity in the system. Balanced Consumer/Investment loan growth would help sustain high GDP growth. The current-account surplus and capital/portfolio inflows are supporting currency/inflation, facilitating higher capital-goods imports. Abundant liquidity will help fund a relatively small fiscal deficit.

 2010 themes, data points — BI’s priority of 20% loan growth will determine its stance on lending rates. With limited room for deposit rate cuts, lower lending rates would hurt NIMs. 1Q10 loan growth of 0.4% is below BI’s expectations and pressure will remain on banks to deliver. NIMs have been rising since mid-09 (up to Jan 10) and credit costs are reverting down to historical averages. Amid weak loan growth, 1Q earnings are expected to be flat (QoQ), though BBRI and BDMN may surprise positively on better loan growth and roll-over of expensive time deposits. As loan growth picks up, competition for deposits will intensify due to skewed LDR (87% exc. 3 liquid banks) – a key reason why we prefer BMRI.

 Risks — Global liquidity impacts both commodity prices and capital flows. BI’s assessment of a marginal impact on inflation of the proposed electricity tariffs and a favorable input-output gap is more benign than other views (Advisor to Finance Minister). Regulatory changes like CRR and less frequent SBI auctions will impact BBCA the most, in our view.