Citigroup Indonesia Banks

Inflation Risk is Rising while Recent Data is Positive: Upgrading BBCA/ Downgrading BBRI

 Impact of tightening — We upgrade BBCA to Hold/Low risk (Sell/Medium) and downgrade BBRI to Sell/Medium risk (Hold/High), on their capacity to maintain growth momentum in a rising interest rate environment (impact NIMs and credit costs and marginal on bond portfolio). BBCA and BMRI will benefit from rising rates, followed by BBNI with a negative impact of BBRI and BDMN. We are raising earnings on BBCA and BBNI (lower credit costs) and lowered BDMN (higher credit cost).

 De-rating unlikely — There have been two de-ratings in the past, but only when inflation crossed 8%. BBCA emerged as the best Defensive Stock. BI is citing a seasonal July inflation spike (6.2%) (food prices and electricity tariff hike) not structural and cites no immediate risks of heating up. Weak USD and rising investment (as a percentage of GDP and bank loans) support its arguments.

 June data and regulations — Record loan disbursement (higher share of investment loans), pick up in deposits (mostly CASA) and spreads maintaining (lending rate spread over bond is widening). The Rp LDR has inched up to 80%. Implementing haircut regulation will be difficult, due to possible criticism that it is favoring some borrowers. Higher LDR will aversely impact earnings of BBCA and BMRI by 2-4%.

 2010 profits driven by lower credit cost — The aggregate profit of four large banks is up 29% YoY and 1% QoQ in 2Q10. Pre-Provision profit is up 5% YoY and 2% QoQ. Aggregate loan loss provisions (net of write backs) were Rp5.1trn, down from Rp9Trn in 1H09 and same as 2H09. Surprises were 1) BMRI, higher asset yield; 2) BBCA, loan growth; 3) BBNI, cash write back and demand deposit increase; and 4) BBRI maintaining momentum.

 Valuations — We value the banks using a Dividend Discount Model to better capture declining bond yields. Nominal GDP growth rate of 12.2% and Risk Free Rate of 9.3% (based on 6% inflation + 3.3% real return in line with historic average). Higher growth rates assumed for BMRI, BBCA and BBRI