CLSA Bank Danamon (BDMN I), Quality over Quantity

Bret Ginesky looks at Bank Danamon (BDMN IJ) 2Q10 results. Danamon reported its 2Q10 net profit of Rp732.0bn, up 4% QoQ and 22% YoY. Net profit for 1H10 of Rp1,433.0bn, up 40% YoY is slightly ahead of our and the consensus full year estimates. Pre provision profits were relatively weak, up 13% YoY, as operating expenses increased 23% YoY due to costs associated with the employee retention program. Maintain UPF rating and TP of Rp4,500.

Two things that we would like to highlight:
(1) Declining earning asset yields, despite the fact that high yield mass market loans as a percentage of total loans have been going up steadily. It is like BBNI is taking more risks without getting rewarded.

(2) Our concern is that the BDMN is locked into a deposit pricing agreement with the top 14 banks and has limited room to increase its time deposit rates to fund loan growth while a penalty for a high LDR is anticipated to be employed by BI in 2011. Most recent indications are that the LDR range will be between 75% and 95%, with BDMN currently at 105% (note: Bret thinks that BDMN’s LDR could go up to 120% without severe constraints since they have enough equity to back them up – thanks to rights issue in 2009).

Key points from the report:
· Earning asset yields have declined for three consecutive quarters and the banks increase in CASA funds has not corresponded to lower funding costs.
· BDMN’s loan growth of 10% QoQ and 15% YoY represented the highest growth in our coverage universe from a QoQ perspective.
· BDMN is locked into a deposit pricing agreement with the top 14 banks and has limited room to increase its time deposit rates to fund loan growth while a penalty for a high LDR is anticipated to be employed by BI in 2011.
· Cost of credit decreased to 3.3%, down 10bps QoQ and up 30bps YoY, as a few recoveries were reported from the corporate segment. The increase in special mention loans is a concern, up to 10.6% of total loans.
· Looking forward we foresee additional headwinds and anticipate earnings growth of a modest 10% in 2011.
· Valuation: at 2.3x and 13.8x 2011 PB and PER respectively, BDMN looks pricey relative to peers, which also offer higher growth and better returns.