RHB Indonesia Morning Cuppa - 23 December 2016 - (Banks)

Good morning,

Sector Outlook: Banks (Overweight) - Still Profitable

¨ Higher loan growth to improve 2017F earnings growth. Our 2017 sector net profit projection is expected to rebound by 11.5% from this year’s estimated flat earnings growth, on:

i. Pick up in loan growth to 15.2% YoY;

ii. 8bps NIM compression due to lower asset yield expectations;

iii. Lower sector credit cost of 186bps, down from 200bps in 2016.

In addition, we expect 2017 sector ROAE to be diluted further to 15.2% from 16.2%, as sector leverage continues to trend down due to higher capital-based allocation, following Basel III capital requirements as well as additional amounts from asset revaluation.

¨ Milder pressure on asset quality. The 3Q16 results (that were largely within our expectations) reflect our on-track projections, with +10.8% QoQ pre-provisions operating profit (PPOP) growth due to:

i. +7.2% QoQ net interest income growth from a lower blended CoF (by 10bps QoQ to 3.4%);

ii. Manageable operating expenses as most banks are limiting their branch expansion;

iii. Yet provisions remain a major drag factor albeit on a smaller scale in terms of impact on Indonesian banks’ earnings.

¨ Lower NIM projection. The authorities’ – Financial Services Authority of Indonesia (OJK) and BI – intention to bring down lending rates to single-digit levels is working gradually after aggressive policy rate cuts YTD by 150bps. Furthermore, we expect OJK to continue to encourage banks to lower lending rates to propel growth, while banks would do so by cherry picking segments in our view, ie corporate and mortgage lending. We thus expect sector net interest margin (NIM) to dip 8bps to 6.5%,due to an offset impact between lower CoF to 2.9%, and a 31bps compression in asset yields to 9.2%.

In the latest round of financial results, overall sector NIM still expanded by 45bps YoY mainly due to a combination of higher asset yields as Bank Mandiri (BMRI) (BMRI IJ, NEUTRAL, TP IDR11,600) and Bank Negara Indonesia Persero (BBNI) (BBNI IJ, BUY, TP: IDR6,800) received one-off interest income payments from Raja Garuda Mas (RGM), and faced lower pressure from the liability side of banks’ books cost following OJK’s cap on maximum time deposit (TD) rates.

Looking ahead, we view government bonds issuance as the imminent threat for customer deposits as OJK requires insurance companies and pension funds to have a minimum 20% exposure to government bonds by end-2016.

Amid the Government’s plan to pre-fund its 2017 state budget through bonds, we expect minimal impact on customer deposits as coupon rates would be similar with TD rates in our view. In addition, c.IDR100trn in proceeds from tax amnesty and c.IDR140trn from asset repatriation would somewhat support liquidity within the system, in our opinion.

¨ Gradual improvement in asset quality. 3Q16 asset quality varied across our banks universe due to different loan exposure. Banks with sizeable corporate lending exposure, ie BMRI and Bank Central Asia (BBCA) (BBCA IJ, NEUTRAL, TP: IDR17,200) still struggled to manage their NPLs, while banks with focus on the retail segment experienced relatively lower NPL pressure.

Sector gross NPLs were flat at 2.7% as at September, with higher loan loss coverage (LLC) ratio of 136.9%. Lower credit costs of 248bps (2Q16: 262bps) can be viewed as a proxy that the pressure has started to ease in a more gradual manner going forward. All in, we expect the sector gross NPL ratio to improve to 2.3% with lower credit cost of 186bps, resulting in higher LLC ratio of 145.2% by end-2017.

Given the projected gradual pickup in Indonesian economic growth to 5.3%in 2017 according to RHB economists, the longer-than-expected time period to see improvements in asset quality remains a key risk in our view.

We prefer banks with a resilient domestic-oriented business model, improved asset quality, and good NIM management amid the low interest rate environment and persistent volatility in global outlook. We believe banks that meet the above criteria would likely outperform. BBNI and Bank Tabungan Negara Persero (BBTN) (BBTN IJ, BUY, TP: IDR2,420) are our Top Picks. (Eka Savitri)

Link to Daily report: Indonesia Morning Cuppa - 231216