JP Morgan - Riz note: How could bank shortly keep its funding cost flat

* By looking at the industry’s data, I believe Indonesian banks could raise up to Rp39 trillion (US$4.3 billion) long dated IDR funding by a) taking the cross currency swap and b) bringing up its non-IDR LDR from currently 68% to 80%. The strategy should temporarily ease concerns IDR funding competition.

* In addition to Bank Danamon (BDMN IJ, Market cap: USD5.0B, Liquidity: USD3.0M/day, and 12.8x FY11 consensus EPS), which has undertaken the strategy, I believe Bank Central Asia (BBCA IJ, USD16.3B, USD5.3M/day, and 15.5x FY11 EPS) and Bank Mandiri (BMRI IJ, USD14.0B, USD11.9M/day, and 12.3x FY11 EPS) could take this strategy.

IDR LDR HAS GONE UOP, BUT USD LDR HAS GONE DOWN,...
With the IDR Loans-to-Deposits Ratio (LDR) in the Indonesian banking industry rose from 64% in Dec-07 to 80% in Jun-10, thanks to the strong economy growth, concerns over the ability of Indonesian bankers to fund the growth of their loans book are rising. The text book mentions that, in an attempt to keep up with their loans growth rates, bankers will have to enter into funding competition, resulting in an increase in funding cost and lower net interest margin. Accordingly, the Indonesian banking sector has underperformed the broad market by 65bp QTD.

However, at the same time, the non-IDR (mostly USD) LDR in the Indonesian banking industry has decreased from 94% to 68%. Huge IDR/USD volatility post the Lehman crisis (during the 4Q08 to 1Q09 period) has discouraged Indonesian companies to borrow in USD. As recently demonstrated by Bank Danamon, this excess offshore USD liquidity could actually be used by the industry to partly cover its IDR liquidity requirement.

...CREATING A CROSS CURRENCY SWAP OPPORTUNITY
How did Bank Danamon do it? The bank entered into a plain vanilla three years currency swap with a number of foreign banks. Under the deal, the bank gives its excess USD to foreign banks and receives IDR from foreign banks. On the other side of the trade, Bank Danamon gives an annual fixed IDR interest rate of 7.75% to these foreign banks and receives 6-month floating USD LIBOR from these foreign banks over the next three years. On the maturity date, the bank will give the IDR back to foreign banks and vice versa at the spot exchange rate. In addition of securing its IDR requirement, Bank Danamon is also able to lock relatively low long-term funding. If the bank issues a 3-year bond at 100-150bp above the sovereign rate today, the bank will have to pay 8.1-8.6% (versus the currency cross swap rate of 7.75%). Kindly go to IHUSW03 and C1323Y in your Bloomberg, to find out the historical time series of the three-year IDR/USD cross currency swap rates and three year IDR sovereign yield, respectively.

Why would foreign banks do it? At the glance, the trade doesn’t make sense as foreign banks normally long USD and short IDR. However, between the Dec-07 to date, the Riz note reader would note that non- residents have also increased their holdings on IDR papers (both SBI and T-bonds) from US$11.3 billion to US$24.0 billion. While these
non-residents are still bullish on the IDR outlook, the need to partially hedge their IDR bond books (by partially swapping their IDR positions with USD) from their risk management perspective has also risen.

As an Indonesian bank is no longer required to provide the breakdown of its loans and deposits by type of currency, it has been becoming difficult for me to accurately identify which other Indonesian banks, which could follow Bank Danamon’s strategy in recycling its excess USD (low USD LDR) for long dated IDR funding. However, based on
channel checking, I believe both Bank Central Asia and Bank Mandiri have opportunities to copy cat Bank Danamon’s move as these banks a) are sometimes USD lenders in onshore money market and b) have aspirations to strengthen their consumer lending, requiring long dated IDR funding.

By looking at the industry’s data, I believe Indonesian banks could raise up to Rp39 trillion (US$4.3 billion) long dated IDR funding by taking the cross currency swap and bringing up its non-IDR LDR from currently 68% to 80%. The strategy should temporarily provide a relief for bankers in funding their rising IDR loans books.