Banks: Flight to safety

Teguh Hartanto

Bahana Sekuritas

Associate Director

Deputy Head of Research

The expected spike in inflation due to fuel price hike on the government’s subsidy cost has caused changes in banks’ business strategy, shifting center of attention from growth to liquidity and quality.  Increased BI rate by 75 basis points to 6.50 percent since February 2012 has led banks to re-price their funding cost accordingly.

This has consequently triggered new equilibrium for banks in balancing between loan growth and quality, suggesting lower risk tolerance.  Based on our regression model, these changes in macro-economic indicators (i.e. interest rates, GDP growth and foreign exchange volatility), yield to lower loan growth expectation of around 19-20 percent compared to 22-23 percent previously.

Additionally, new loan underwritings will be apportioned towards selective debtors and specific market segments.  In mortgage, for example, potential bubble in the property market within certain locations has discouraged banks to aggressively lend out.  On the regulation front, the central bank, sharing the same perspective on this potential risk in property, plans to alter regulation on Loan-to-Value for mortgages, helping to prevent ballooning non-performing loans going forward.

Apart from loan growth outlook, recent interest rate hikes have also resulted in higher bonds yields.  This drop in bond values translates to potential losses on values of marketable securities within banks’ earnings assets portfolio, as bonds that fall under trading and available-for-sale categories must be recorded after taking into account value differentials against their profitability and equity.  Note that 10-year government bond yields have increased 270 bps since end 2012 to reach 7.8 percent, bringing down bond pricing by around 18 percent.

Hence, banks’ future profitability will depend on the ability of banks to depend on several issues:  1) liquidity management as banks’ industry average Loan-to-Deposit Ratio reaches 87 percent, 2) ability to pass on incremental funding costs to debtors without affecting loan quality and 3) careful expansion plans ahead to keep operating cost at bay.

Note that although the industry’s gross NPL indicated a historical low level of around 1.9 percent (excluding channeling), loans that fall under special mentioned category has been on an uptrend.

On a more positive note, overall outlook for Indonesia’s banking sector remains promising, supporting GDP growth at 6-7 percent.  At this stage of the cycle, the sector has in fact turned out to be more prudent and responsive, providing positive sentiment compared to historical performance.

However, slow-down in banks’ earnings appears inevitable, growing at an average of 12-13 percent versus 17-18 percent based on our earlier estimates.  That said, we believe that the industry will continue to move in line with market performance (ytd: 2.1 percent market outperformance).

Amongst the listed banks in the Jakarta Stock Exchange, we prefer investors to remain invested in the safety of banks with strong deposit franchise and sound-quality assets, providing a shield against downturn in macro-economic outlook.