Danareksa Bank Rakyat Indonesia (BBRI IJ, Rp9,900 BUY) Still very profitable

Micro-focused, TP of Rp12,200
Our BUY recommendation is based on the premise that the bank’s unique business model – specifically in the area of micro lending - high profitability and above industry loans growth will be sustained over the longer run. ROE has also been robust, at above 28% in 1H10, thanks mainly to the bank’s higher proportion of productive assets. NIM, while it has been declining since 2005, remains above the industry’s average. Loans growth continues to surge, hitting 11% year-to-date, albeit with slightly lower quality. Micro lending continues to be the bank’s main focus. The 1H results are not a surprise at all, and for the time being, our forecast remains unchanged. As for the TP, we extend it to 12-months, raising it to Rp12,200 or 4.0x FY11 PBV, justified by the 21% 3-yr EPS growth and 32% ROE.

Tackling its NPLs
1H10 NPLs rose to 4.3% as loan quality in the small commercial and medium segments continued to deteriorate. Total bad debts written off were around Rp800bn, mainly in the micro and retail segments, with the bank attempting to recover bad debts in other segments – specifically the medium segment – from restructuring. NPLs in the medium segment jumped to 14.9%, despite the bank’s efforts to tackling them through extensive restructuring. Thus far, more than half of the medium NPLs have been settled and around 30% of them are still being restructured. Assuming 50% of the settled NPLs are upgraded, then the medium NPLs are likely to reach 11% by YE10, in our estimates. Like the medium NPLs, bad debts in the small commercial segment have picked up as well, with the NPLs up to 6.5% in 1H. However, the management’s guidance is for small commercial NPLs to fall to 5% in 2H, as restructuring progresses. Should NPL targets in both segments be achieved, NPLs should fall to 3.6% by YE10, in our estimates, assuming 25% loans growth.

Sustaining high profitability
The NIM stayed at 9.4% in 1H, mainly on deposits re-pricing, although higher loans growth may also have helped. NIM guidance remains at 8.5-9.5% by YE10, or around 8.7%, in our estimates. While this is far from its 4-yr average, it is still above the industry’s average. Our assumption takes into account the greater funding needed to keep the bank’s loans growth at 25%. Indeed, the LDR has reached 88% and the easiest way for the bank to grow its deposits is to increase the proportion of TD, a product that is sensitive to interest rates. This appears to have been the case so far with the bank’s TD increasing to 42% from FY09’s 39%. Of course, the best way is still for the bank to grow its CASA to 60%, but this may take some time to be realized. Alternatively, BBRI could issue sub-debt to finance its loans expansion, while, at the same time, increase its Tier 2 capital. Whatever strategy the bank adopts, it will likely lead to a higher COF - although not by much.

CASA in focus
BBRI’s deposits growth was lacking in 1H. Much of the increase in deposits was mainly in TD rather than CASA. The priority has now shifted towards growing its CASA, through extensive marketing efforts, outlet expansion and product innovation. Cross selling is also helping, especially since the bank has more than 7mn debtors that the bank can tap and some 6,400 micro outlets. Presently, around 65% of BBRI’s saving accounts come from its micro segment. BBRI’s commitment to expand its infrastructure may come at a cost, but given its historic low cost-to-income ratio (CIR) of 41%, there is plenty of room for the bank to increase its presence, without hurting its earnings. We have assumed that the CIR increases to 45% by YE10.

Danareksa Bank Rakyat Indonesia (BBRI IJ, Rp8,450 BUY) Micro driven growth

Reality check; BUY retained
We raise our 3-yr CAGR loan growth estimate to 23% p.a., driven largely by brisker micro loans expansion, supported by stronger consumption growth and benign inflation. This is a reasonable estimate, we believe, since BBRI’s micro loans have grown 23% over the past 5 years, exceeding the industry average of 21%. BBRI’s uncontested rural presence, with 4,500 micro outlets, has helped the bank grow its high yielding loans - and deposits too. This shall remain the case going forward, in our view. Along with higher loans growth, we raise our provisioning expenses to around 2.0-2.5% of average loans to be on the conservative side and trim our NIM to 8.7% - lower yes, but still far above the industry’s average. Our FY10-11 EPS estimates are therefore lowered by 6-14%. However, we still arrive at a higher TP of Rp9,900 thanks to the increase in our loans growth estimate. Our new DDM derived TP implies 3.9-3.3x P/BV 2010-11, at the high-end of its trading range, but justified by the bank’s above-industry loan growth, superlative NIM and robust ROE.

Plenty of room to grow its micro loans
We expect BBRI’s micro loans to grow 24% over the next 2 years, accounting for 28% of the total loans portfolio. Competition to extend micro loans has admittedly escalated in recent years - with banks attempting to extend higher yielding loans to the growing middle-low income population – amidst stronger consumption growth. However, BBRI remains ahead of the pack thanks to its extensive infrastructure and, in particular, its rural network. This year, the bank will open another 50 micro outlets. Some of them will even be in major cities with the idea of garnering cheap deposits so that they can later be channeled to borrowers in rural areas as high yielding fixed rate loans. With an estimated LDR of 86%, the bank has to search for more deposits. The prospects in this segment are good and it is important to realize that it is far from mature - micro loans per borrower are estimated to be only Rp2.2mn in 2009, or far below BBRI’s average of Rp10mn per borrower and significantly below BI’s limit of Rp50mn/ borrower.

Cross selling shall help the bank grow its deposits
The bank’s NIM shall inevitably decline this year (to 8.7%, in our estimates). Larger deposits are needed, especially if BBRI is to grow its loans in excess of 20% p.a., but the focus is more on growing its low cost funds. Opening micro outlets is an alternative, but corporates is another option. The idea is to lend to corporates at 50bps below the normal rate of 11-12% or at the prime rate, with the aim of attaining greater fee-based income and deposits. The lending rate will be low, but with the overall lending to corporates kept at about 18-20% of the bank’s total loan portfolio, there will be minimal impact on BBRI’s overall asset yield. The focus will be on SOE companies, for which NPLs are virtually zero.

Sub-debt issuance is a likely scenario
There is potential risk to BBRI’s CAR of 13% - in particular since implementation of the Basel II accord on operational risk shall cut its CAR by 1.5-2.0%, in our estimates. BBRI views 12% as a minimum level for CAR, although this is insufficient if it seeks to grow its loans in excess of 22% p.a. Unlike other SOE banks, the issuance of sub-debt - rather than raising equity – is the best option for the bank given that the latter would result in potential earnings dilution with no extra tax benefits (one downside though is the higher COF from the additional cost of debt). While we believe that the bank’s capital is sufficient this year (partly due to last year’s Rp2trn sub-debt issuance), a further decline in capital is expected next year. For now, there is no definite plan for additional sub-debt issuance although the bank’s management hasn’t ruled out the possibility of a sub-debt issuance in 2H10.

Danareksa Bank Rakyat Indonesia (BBRI IJ, Rp5,800 BUY) Gathering pace

TP raised to Rp8,200
We raise our FY10-11E EPS estimates by 9-19% on a brisker loans growth assumption. This upgrade reflects our increasingly bullish view on the prospects for the economy with interest rates at all-time lows and inflation being benign. Yet despite the robust loans growth, the bank’s CAR shall remain above 13% in FY10E, supported by an expected Rp2-3trn sub-debt issuance. Accordingly, we raise our TP to Rp8,200 from Rp6,300 previously, assuming a cost of equity of 16% compared to 20% previously. Our new TP implies 4.0-3.4x FY09-10E PBV, admittedly at the high end of its historical trading range yet fully justified in our opinion considering the bank’s robust loans growth, strong NIM, high ROE and exposure to consumer recovery.

Brisker loans growth expected
Our 5-6% upward adjustment to the bank’s FY10-11E loans growth takes into account a number of bullish factors. First of all, interest rates are at an all-time low of 7%. Moreover, they may even head lower since the benign inflation has given BI more room to loosen monetary policy further. Another positive is the 4-6% consumption growth expected over the next two years helped by a Rp40trn tax stimulus (note that private consumption is already in good shape, growing a brisk 5.8% in 1Q09). Lastly, BBRI has plans to issue sub-debt in 2H09. This should help keep its capital at a healthy level, we believe. The amount to be raised is likely to be in the range of Rp2-3trn, bearing an indicative cost of 12% p.a. and with a maturity of 10 years. This debt issuance will keep the bank’s CAR above 13% in FY10E (even with loan growth in excess of 20% p.a.). Despite the additional sub-debt, BBRI will still keep its NIM above 9.5% and its COF below 4% in FY10-11E, in our estimates.

Good 2Q09 profits
April’s loans grew Rp5-6trn from Rp165trn in March, or among the highest in the sector. Seasonality is certainly one factor, in our view. It is interesting to see that BBRI’s lending rate has not changed much (at 15-17%) despite the rate cuts of 250bps since early this year. This is because lending rates for micro and small commercial loans (together accounting for more than 50% of the bank’s total loans) tend to be sticky at around 20-25%. In addition, the bank has also maintained high lending rates in order to offset the higher COF of 5% vs. 4% normally. By offering attractive deposit rates, the bank can maintain the amount of deposits. Against this backdrop, we believe the bank’s NIM should be stable at 9.5% in 2009. Note that the bank’s 1H09 results will probably be released in August because of its plans to issue bonds.

NPLs are under control
April’s NPLs are pretty much unchanged from their level in March of 3.24%, according to the management, but a slight increase by the end of 2Q09 is inevitable, we believe. Loans to the micro segment, in particular KUR (loans channeled to non-bankable clients), and medium business, are likely to account for the bulk of new NPLs. We forecast NPLs of around 3.6% by the end of 2Q09. NPLs shall peak in 3Q09, with loans starting to pick up in 2Q09. But with the loan restructuring continuing apace, we stick with our forecast of 3.3% NPLs by YE09. The provisioning booked will increase by at least 20% in 2Q09, assuming an expected 10% QoQ increase in 2Q09 loans growth. This is 27% of our FY09 forecast. But since BBRI will only start to lend aggressively in the second half of the year, we expect provisions for bad debts to peak in 3Q09.