Banking on Indonesian Growth

Peter is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

By the end of the 2nd quarter of 2012 it became clear that Indonesia was going to be the engine of growth for ASEAN over the next few years.  With GDP growth exceeding expectations at 6.5% and foreign investment rising 30.2% year over year the worries over political and fiscal distress in Europe and the U.S. faded somewhat.  Now that the Western central banks have announced some form of open-ended quantitative easing there isn’t a more critical time to reiterate the great opportunity that Southeast Asia represents as a major producer of wealth in the world.

The biggest worry for emerging markets has been the potential for a collapse of the Euro (NYSEMKT: FXE) and with it a collapse in the U.S. which would cause global trade to suffer and emerging markets to become starved for new capital inflows.  QE to infinity is on the table now, with the Fed and E.C.B. targeting nominal GDP growth regardless of what they actually say.  This will be bullish for the emerging market economies that have been struggling with falling currencies due to the fear trade centered in the West.  They can expect capital to flow quickly out of the U.S. bond market and the U.S. Dollar and into places where real yield can be found. 

But a funny thing has happened in the past couple of weeks on the way to infinite monetary debasement, the U.S. Dollar has continued to rise as the Euro is pulled back below $1.29.  Since the EURUSD exchange rate is dominating all of the markets, weakness in the Euro is translating into USD strength across a number of currencies, including those viewed as vulnerable, like the Indonesian Rupiah.  On the QEIII announcement a number of currencies that had been abused during the summer’s fear trade looked to have made significant reversals, but the Rupiah is still being sold on weak coal and iron ore prices, closing at 9592.9 to the USD on October 8, the highest closing price of the year.  The new coal export tax will be put in place after the horse has left the barn, as it were.  Now that there is little export demand thanks to an over-supply in China and what is likely to be the end of the Chinese steel trade

In the midst of this, Indonesia’s banks have profited very handsomely due to the Bank of Indonesia’s relatively loose monetary policy driving high-double digit credit growth.  Since their reserve requirements are not based on a loan to assets ratio, wherein the value of the property being loaned against is counted in the calculation, Indonesia’s banks are required to manage their leverage versus their deposit ratio, which is much more akin to traditional banking.  This keeps the leverage in their banks lower, 7.6 times assets at the end of 2011, according to the year-end report by Price Waterhouse Cooper, than their U.S. counterparts.  The range is 78% to 100% of deposits, above which they are required to automatically increase their reserves or decrease their loan portfolio. 

The banking sector in Indonesia is expanding rapidly and as such represents both a great investment opportunity as well as a bit of a nightmare.  In a situation common to emerging and frontier markets the world over the rate of growth may be limited by their access to qualified staff.  Nearly 70% of the banks in Indonesia felt that this was the most important factor in curtailing future growth in 2012.  Turnover is high, averaging more than 10% of staff annually and yet a majority of banks want to increase staff by at least 10%. The Bank of Indonesia is pressuring banks to streamline their operations to improve both profitability and the sector’s overall health. 

The Bank of Indonesia recently decided to hold interest rates at 5.75%, consistent with their regional neighbors Malaysia and Thailand who have also held the line in the face of falling currencies and exports to the West.  This is signaling a shift in approach as ASEAN moves towards further economic and trade integration as they are not fighting each other to boost exports by trying to debase in line with the West.  Indonesian banks, in general, enjoy net interest margins that are far above levels seen in more developed Asian countries, meaning the arbitrage between loan rates and deposit rates are among the highest in the world. 

The big issue hanging over Indonesia’s banks, however, is the implementation of Basel III as there is a real dearth of Tier I equivalent assets in country which will put a strain on their ability to maintain capital adequacy ratios.  Due to very generous deposit insurance the banks, while stable now, are lent long based on demand deposits and 1 month term deposits.  For them to be assured of adequate liquidity under Basel III it may require the banks to change the structure of their deposits towards longer-term deposit vehicles.

Moving towards becoming gold trading houses would be prudent as well, for while gold is still held at 50% of its currency value right now, in all likelihood by the time Basel III rules go into effect gold will be a Tier I capital asset, if not re-emerge as the anchor for a new global monetary system.  Singapore’s government and banks understand this, for Indonesia to be the biggest ASEAN economy, their banking sector needs to see the writing on the wall.

Here’s a quick review of three of Indonesia’s biggest banks that heavily featured in both Indonesian ETFs, the Market Vectors Indonesia Index ETF (NYSEMKT: IDX) and the iShares MCSI Indonesia Index ETF (NYSEMKT: EIDO).  Both funds hold ~21% of their assets in these three banks.

Ticker

AUM

%Yield

%Return YTD

BBCA

BBRI

BMRI

EIDO

$300.6M

1.50%

3.99%

8.56%

7.27%

6.73%

IDX

$393.7M

2.54%

1.43%

7.70%

6.33%

6.19%

 Bank Rakyat Indonesia (BBRI): BRI is the 2nd largest bank in Indonesia by assets and has a market cap of just over $19 billion USD.  It is 70% owned by the Indonesian government and is primarily focused on microfinance and lending to SME’s.  Its microfinance business made up 32% of its MRQ revenues only slightly behind those of commercial lending.   Net interest margin was 8.4%, though down, it is the highest in the world outside of say Cambodian microfinance where the interest rate differential is closer to 15%.  BRI is trading at a multiple of 10.4 and is paying a 3.3% yield.  Return on Assets, however are a poor 0.9%.  A strong 2nd quarter had profit rising 30% year over year even though credit growth was behind the industry average at 14.6%, this allowed them to shrink their loan-loan reserves and boost bottom line profits. 

Bank Mandiri Indonesia (BMRI): Bank Mandiri also trades an ADR trading in the OTC market in the U.S. ticker PPERY, is Indonesia’s biggest lender by assets with branches in Singapore, Shanghai, the U.K., the Cayman Islands and Timor Leste.  It is considering opening up branches in Vietnam, Myanmar and Thailand to challenge Singapore’s DBS group for largest bank in Southeast Asia. It, like BRI, is mostly owned by the Indonesian government.   Bank Mandiri is still dealing with the remains of the Asian monetary crisis of the 1997-98 and recently swapped out debt maturing in 2016 and 2017 with loans from Standard Chartered to free up working capital.

Its securities subsidiary is planning an expansion into Singapore to tap into the capital flowing into the region from the West, while it is also considering an IPO for its Sharia-compliant Islamic banking unit to serve that rapidly growing market in both Indonesia and Malaysia.  Net interest margin rose slightly to 5.38% while ROA (3.35%) and ROE (25.19%) both fell slightly year over year in the 2nd quarter along with their Gross NPL ratio which dropped from 2.22% 1.95%. 

BMRI trades at a forward multiple of 13.2 and pays a 1.3% dividend. 

Bank Central Asia (BBCA):  The nation’s third largest lender has been branching out into insurance and annuity products in the past year, after it decided to pull out of neighboring Malaysia due to what they felt were onerous regulations which pushed their return on investment too far into the future.  With the announcement by Prudential (NYSE: PRU) that their insurance business in Indonesia is now bigger than that of their three top competitors combined it only made sense that a local player would step into what looks to be the most lucrative and fastest-growing insurance market in the world.  Bank Danamon, which DBS Group’s bid for is still in limbo over because of a proposed change in foreign-ownership rules, has partnered with Manulife’s (NYSE: MFC) Indonesian division to sell their products.  BCA will not pursue an M&A strategy with this move, like it did for its brokerage and Islamic banking units, but rather build it organically through its branch network.

BCA is currently trading at a multiple of 17.3 and paying a 1.4% dividend.  Its net interest margin in Q2 2012 was 2.25% down from 2.36% year over year. 


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