Danareksa Bank Danamon (BDMN IJ, Rp5,350 BUY) Strong mass market profitability

Remaining very profitable
We trim our FY11-12E earnings estimates, taking account of the imminent bond issuance and the slightly lower 3-year loans growth to stay aligned with the deposits growth. This year’s forecast, however, is intact. The bank’s 1H results were not a surprise at all. Most of the gains are largely due to strong mass-market loans growth, aside from the absence of derivatives provisioning. The NIM stayed at an impressive 11.6% and is likely to increase in 2H, as efforts to tackle high cost funding shall reduce the COF. Meanwhile, the ROE improved to 19% despite the bank’s high capitalization. BDMN remains our top pick in the banking sector given its strong capital base, robust NIM in excess of 11% (post adjustment of PSAK 50/55), and sustainable loans growth. Its exposure to domestic consumption growth shall also ensure that our 38% 3-yr CAGR EPS growth estimate will be met. We set our 12-mth DDM TP at Rp6,850 or 3.0x FY11 PBV. BUY maintained.

The power of the mass market
Our loans growth estimate is still 21% for 2010, a figure that can easily be achieved. Thus far, BDMN’s loans have grown by about 12%, thanks to the bank’s staggering 28% YoY loans growth in the mass market. This segment has accounted for 56% of the total loans portfolio - and will likely stay at this level for the remainder of the year. Loans expansion is seen in all segments, with the exception of retail loans - which only contribute about 7% of the bank’s total loans portfolio. BDMN’s strategy, however, remains in place; that is to grow its consumer loans, a segment that could generate a very healthy NIM of 18-20% and an asset yield above 18% - allowing BDMN to compensate for its high COF and operating risks. Moreover, we do not exclude the possibility that the bank will also grow its corporate loans, as they are needed to boost the bank’s cross-selling activities.

Reducing its COF
The bank’s COF has continued to decline. It dropped to 5.4% in 2Q10, down from its peak of 8.39% in 1Q09, mainly due to a higher proportion of CASA – some 39%, aside from re-pricing of expensive time deposits. On a year-to-date basis, CASA has grown by as much as 16.5% thanks to the bank’s innovative products and infrastructure improvements. This includes expansion of its ATM network – around 250 ATMs this year – as well as adding new branches and transactional facilities. However, the overall deposits growth has been unexciting so far. This also suggests that the bank’s search for funding may potentially tilt towards high cost time deposits. Funding has become critical, as the LDR reached 99% in 1H10. Meanwhile, the bank’s imminent Rp5trn bond issuance will only secure next year’s loans growth. Hence, the proportion of CASA is likely to decline in 2H10. Our forecast assumes the proportion of CASA stays at 30% this year, before increasing to 35% next year.

Better loan quality
Our gross NPLs estimate remains at 3.1% at year-end. 1H10 NPLs reached 3.4%, down from 1Q10’s 4.0%, consistent with the economic upturn. The mass market still contributes the largest NPLs – some 48% of the total NPLs - or NPLs of 1.6% - yet lower than 1Q10’s 1.7%. This is not so much due to write-offs, the management believes, but more on the recovery of bad debts. Indeed, the proportion in the special mention category increased to 10.6% of total loans, suggesting loan upgrades were more likely than not. The cost of credit has been relatively unchanged on a QoQ basis, but is likely to see a reversal toward the end of the year.

1H10 Key highlights:
1H10 NPAT hit Rp1.4trn, +65% YoY thanks to higher fee based income aside from the absence of extraordinary items related to derivative transactions. On a QoQ basis, earnings actually grew by 4% QoQ, supported by a slight decline in the cost of credit and fees related to credit. Loans growth has picked up, reaching 10% QoQ.

The NIM eased to 11.6% from 4Q09’s 13.4%, largely due to reclassification of acquisition costs from previously “deducting fee income” to now “deducting interest income”. NPLs improved slightly to 3.4% from 1Q10’s 4.0%, with the micro lending business contributing most of the NPLs. Provisioning coverage is almost 100%.

CAR is strong at 19.5% as of 2Q10 prior to implementation of Basel II operational risk. With operational risk, CAR is about 18%. Meanwhile, ROAE improved to 19.3% from 1Q10’s 18.0%.

In short, no surprises. Worth noting, however, is reclassification related to implementation of IFRS. This has led to a decline in interest income, hence its asset yield. Indeed, the asset yield dropped by 150bps from 4Q09’s 18.3%, more than offsetting the 60bps decline in the quarterly COF. NIM therefore eased, although it was still higher than 2Q09’s 10.8%. As for the remainder of the year, the bank’s guidance is for an 11-12% NIM.

Profitability is strong, with the company posting its largest ever quarterly profits. Derivative-related provisioning is no longer an issue, with the company now seeing a huge jump in ROE, despite last year’s rights issue. All in all, the bank is looking for 20% ROE by the end of the year.

Higher profits were also thanks to the slightly lower cost of credit of Rp562bn in 2Q10, or down from 1Q10’s Rp578bn. This is despite a higher cost-to-income ratio of 50.8% compared to 1Q10’s 47.5%. Note that the cost of credit related to the mass-market business declined, even though the bank aggressively grew its mass-market business– an effective and efficient strategy.

Loans growth improved. Growth was seen in all segments, with the exception of retail loans. Mass market loans saw a 12% QoQ increase, backed by strong auto financing and micro lending. This segment now accounts for 56% of the bank’s total loans portfolio. The idea is that the bank sustains its high asset yields with longer duration.

Funding could still be a concern in the near term, we believe. Deposits have not grown as expected, despite their better structure. Yes, CASA now represents around 39% of the total deposits thanks to retirement of costly deposits amid improving liquidity. But this will not last, especially since the LDR has reached 99%. Hence, we expect the proportion of time deposits to increase in the next 1-2 quarters. Note that deposits account for 89% of BDMN’s total funding. The rest comes from bonds, REPO and other LT borrowings.