ASIAN BANKS GLOBAL EQUITY RESEARCH Indonesia ASIA Indonesian Banks: Accidental Stars As Risk Spreads To All Markets, Indonesia Is Outperforming. Paul Sheehan 852.2869.3001 [email protected] (cid:1)(cid:1) 3BJTJOH(cid:1)UP(cid:1)/FVUSBM(cid:15) We are raising our sector weighting on Indonesian banks to NEUTRAL from UNDERWEIGHT based on fundamental financial performance Grant Chan 852.2869.3818 which is too good to ignore. The country risk remains high, but we have seen this [email protected] year that sticking with large or politically stable markets is no insurance against volatility. Although our universe of traded banks in Indonesia is limited, we see Graham Parry(cid:1)Economics opportunities for investors to reap outsized gains over the next twelve months. 813.5571.7481 [email protected] (cid:1)(cid:1) "(cid:1)7BMVF(cid:1)0VUQFSGPSNFS(cid:27) Indonesia has been quietly outperforming larger Asian markets, and the bank sector has likewise outperformed the broader Indonesian Bertram Lai 852.2869.3024 market. Our covered universe of stocks has risen by an average of 23% YTD, and [email protected] the sector does not yet look expensive(cid:1)valuations have in some cases fallen, even as returns increase. Christine Lam 852.2869.3813 (cid:1)(cid:1) "TTFU(cid:1)2VBMJUZ(cid:1)JT(cid:1)3FDFEJOH(cid:1)BT(cid:1)BO(cid:1)*TTVF(cid:27) Asset quality has been the driving focus [email protected] of the sector(cid:1)and a major negative(cid:1)for three years, but recapitalized banks Amy Wong have maintained clean records on new lending and have the financial strength to 852.2869.3127 write off their remaining problem loans, which they are doing aggressively. [email protected] (cid:1)(cid:1) $POTVNFS(cid:1)#BOLJOH(cid:1)JT(cid:1)B(cid:1)1SJNF(cid:1)5BSHFU(cid:27) Going forward, successful players are turning their retail deposit franchises into integrated consumer and SME banks, with plenty of room to grow in this business. (cid:1)(cid:1) -FOEJOH(cid:1)4FU(cid:1)UP(cid:1)3JTF(cid:27) Indonesia is well below regional averages in credit to GDP (only 21%) and consumer lending to GDP (6%), lagging substantially behind even Korea and Thailand. This bodes well for loan growth as economic activity picks up over the next several years(cid:1)and the positive effects are already making themselves felt. (cid:1)(cid:1) 8F(cid:1)-JLF(cid:1)#$"(cid:27) Our favorite bank in the sector remains BCA, the premier consumer bank and one with a very clean balance sheet now selling at 95% of book value and 4.3x trailing earnings. We also see potential value in Lippo Bank, a more distressed situation but one also offering the opportunity to own a top franchise at a bargain price. September 27, 2001 http://www.lehman.com Indonesian Banks: Accidental Stars Table of Contents Investment Summary...........................................................................................3 The Indonesian Banking Scene............................................................................5 Industry Growth and Prospects.............................................................................7 Financial Performance......................................................................................11 Valuation........................................................................................................13 Indonesia’s Bank Restructuring(cid:1)A Recap Review..................................................15 Political Scene................................................................................................20 Economic Outlook...........................................................................................22 BANK CENTRAL ASIA.....................................................................................28 LIPPO BANK...................................................................................................35 PANIN BANK................................................................................................41 Table of Figures..............................................................................................46 "…numerous indicators of fraud, noncompliance, irregularity, misappropriation, undue preferential treatment, concealment, bribery and corruption…” —Bank Bali Audit Report, 2000 2 September 27, 2001 Indonesian Banks: Accidental Stars Investment Summary Neutral on Indonesia We are now NEUTRAL on Indonesian banks, up from UNDERWEIGHT at the beginning of the year. Although our universe of traded banks is small, fundamentals for the sector are good and the financial performance of our covered institutions has been strong. As a consequence, even as Indonesia has been quietly outperforming other Asian markets, the bank sector has outperformed the broader Indonesian market. Our covered universe of stocks has risen by an average of 23% YTD, but the sector does not yet look expensive. Our favorite bank in Indonesia remains BCA (BBCA, IDR1,325, 1--Strong Buy), with Lippo Bank (LPBN, IDR40, 2—Buy) also beginning to look attractive at these levels. Although the remaining bank we cover, Panin (PNBN, IDR240, 4—Market Underperform), is financially sound and will be a long-term survivor, we believe that shareholders will suffer further pain in the short run, as the bank works through its asset quality problems. Key Points (cid:1)(cid:1) *OUFSFTU(cid:1)4QSFBET(cid:1)"SF(cid:1))FBMUIZ(cid:27) Indonesian banks are earning the highest interest margins of any group in our Asian banking universe, with average NIM of 5.19%. This robust underlying profitability has helped banks pull themselves out of difficulty(cid:1)a feature still missing in markets like Thailand. (cid:1)(cid:1) #BE(cid:1)-PBOT(cid:1)/PX(cid:1).BOBHFBCMF(cid:27) In part because banks have earned enough money to take write-offs, and in part due to IBRA’s removal of bad loans, asset quality at those Indonesian banks we cover is recovering quickly, with some banks, like BCA , almost completely clean at this point. (cid:1)(cid:1) $PNNFSDJBM(cid:1)#BOL(cid:1)$SFEJU(cid:1))BT(cid:1)3PPN(cid:1)’PS(cid:1)&YQBOTJPO(cid:27) After write-offs and workouts, Indonesia has commercial bank credit outstanding amounting to only 21% of GDP, down from an average level of 45% between 1993 and 1997 and a peak of over 70% in 1998. In terms of leaving room for growth, the credit to GDP level in Indonesia compares quite favorably with 41% in the Philippines, 61% in Korea, and 91% in Thailand. What Has Been Done (cid:1)(cid:1) $BQBDJUZ(cid:1)5BLFO(cid:1)0VU(cid:27) Indonesia has closed or merged 87 banks, and is forcing many other financially sound but small institutions to seek merger partners or increase their capital. (cid:1)(cid:1) /1-T(cid:1)3FNPWFE(cid:27) Indonesia’s listed banks have been forced to recognize their bad assets, and the worst of these have been removed by the government, leaving the banks cleaner than those in Thailand or Korea. (cid:1)(cid:1) 3FNBJOJOH(cid:1)#BOLT(cid:1)3FDBQJUBMJ[FE(cid:27) Of the remaining banks, the majority have been effectively recapitalized with government bonds, and IBRA has demonstrated a September 27, 2001 3 Indonesian Banks: Accidental Stars commitment to ensure that banks still under its charge are safe and sound before removing them from administration. This has eliminated a major source of systemic risk. (cid:1)(cid:1) #BOL(cid:16)$PSQPSBUF(cid:1)4USVDUVSFT(cid:1)#SPLFO(cid:27) The cozy relationships between Indonesia’s corporate groups and their bank affiliates have been largely broken through shareholder settlements and use of the ‘fit and proper’ test, although insidious influence has not vanished entirely from the market. What Remains to be Done (cid:1)(cid:1) $POUJOVF(cid:1)#BOL(cid:1)1SJWBUJ[BUJPO(cid:27) IBRA has been slow to sell its stakes in banks, although poor market conditions have not helped any. Apart from the initiation of a tortuous sale process (in several tranches) for BCA, the government has yet to float or otherwise dispose of any banks. Bank Mandiri is scheduled to be listed next, but its cumbersome structure and recent integration of BII make this an uncertain prospect. IBRA should offer remaining banks (even at fire-sale prices) in order to put productive assets back to work in the private economy. (cid:1)(cid:1) 4FMM(cid:1)3FNBJOJOH(cid:1)"TTFUT(cid:27) Although IBRA’s recapitalization of banks and preservation of the banking system has been quite effective, its disposal of assets taken from liquidated and recapitalized banks has been far too slow. The longer these assets are held, the less value they have. (cid:1)(cid:1) 3F(cid:14)5IJOL(cid:1)4UBUF(cid:1)#BOLT(cid:27) It has been proven time and time again that governments should not be in the business of lending(cid:1)and Indonesia is no exception. The former state banks were generally worse lenders than the private banks, and are significantly less efficient to boot. Indonesia’s new administration needs to either devise a compelling rationale for keeping the government in the banking business, or find a clear and swift exit strategy. (cid:1)(cid:1) &GGFDUJWFMZ(cid:1)3FHVMBUF(cid:1)(PJOH(cid:1)’PSXBSE(cid:27) Bank Indonesia, the Central Bank, still needs to be recapitalized and cleaned up; this should be a priority of the new finance policy staff. In addition, an unambiguously professional supervisory staff must be institutionalized to ensure that banks stay on the straight and narrow. IBRA should also work to implement privately funded deposit insurance to replace the blanket government guarantee as soon as practicable. 4 September 27, 2001 Indonesian Banks: Accidental Stars The Indonesian Banking Scene Indonesia has closed 87 Who’s Left? commercial banks and Indonesia’s banking sector has consolidated quite significantly over the past two years, but consolidated the industry remains more fragmented than in other Asian markets. However, the merger and liquidation process has reduced the number of banks by 37%, with some 87 commercial banks no longer in existence. Of these, 70 have been frozen or liquidated, with the remainder merged in an attempt to create viable institutions. In some cases, such as the eight-way merger which begot Bank Danamon, this strategy appears to have worked; in others such as the combination of four state banks (and now BII) into Bank Mandiri, the jury is still out. Figure 1: Indonesia’s Banks by Category: 1997--2000 Oct-97 Dec-00 Change % State Banks 7 5 (2) -29% Private National Banks: Foreign Exchange Banks 115 67 (48) -42% Category A Banks 28 Recapitalized Banks 6 Taken Over (BTO) Banks 4 JV Banks and Other 29 Domestic Only Banks 79 43 (36) -46% Regional Development Banks 27 26 ( 1) -4% Foreign Banks 10 10 - 0% Total Commercial Banks 238 151 (87) -37% Total Commercial Bank Branches 7,781 6,509 (1,272) -16% Source: Bank Indonesia Although many of the liquidated banks were small (and indeed some banks like BCA were rescued only because they were “too big to fail”), the total number of bank branches has declined by 16%, and we expect a further fall as remaining large banks prune their low-performing branches. Figure 2: Bank Market Share by Category: June 2001 Deposits As of June, 2001 Assets All Demand Time and Savings State Banks 50.1% 46.6% 32.0% 49.5% Private Banks 34.6% 43.5% 39.3% 44.3% Foreign Banks 10.5% 3.6% 6.3% 3.1% Joint Venture Banks 4.7% 1.0% 1.7% 0.9% Regional Development Banks 3.4% 5.3% 20.7% 2.3% Source: Bank Indonesia Who’s Better, Who’s Best? At this point there are only a handful of significant Indonesian banks remaining, although there is a possibility that IBRA may create several more through mergers of its remaining portfolio of banks. Of the top ten banks in our estimation, six are full state banks, and the government owns a majority stake in two of the remaining four. We divide these banks into those concentrating September 27, 2001 5 Indonesian Banks: Accidental Stars on a mass retail and SME business (BCA, Danamon, Lippo, Panin, NISP), and those still operating in a traditional manner while waiting to be listed (Mandiri, BNI) or sold (Niaga, Universal, Bali). Only those in the first category can be of interest to investors in listed shares. Figure 3: Major Indonesian Banks Total Assets Status Market Share Branches Mandiri 261,285 State Owned 24.7% 623 BNI 117,880 State Owned 11.1% 636 BCA 104,573 Public 9.9% 795 Danamon 56,093 State Owned 5.3% 497 Lippo 24,070 Public 2.3% 390 Niaga 18,699 State Owned 1.8% 95 Panin 15,881 Public 1.5% 113 Universal 11,320 State Owned 1.1% 69 NISP 5,686 Public 0.5% 73 Bali 5,652 State Owned 0.5% 265 Total 621,139 58.7% 3 ,556 Source: Bank Indonesia, company reports, Lehman Brothers estimates. We believe that BCA, Lippo, and Danamon will survive as the major national retail banks, and also garner a fair share of the corporate business in the years ahead, as they begin with all of the advantages(cid:1)clean balance sheets, large branch and ATM networks, good brand names, and voluminous existing customer bases on the deposit side. While no Indonesian bank has yet made a go of the consumer lending sector (pre-crisis this having been the purview of finance companies), it stands to reason that these banks will have the best ability to do so in the future. Panin and NISP have good potential futures as niche banks in high-margin sectors, and may be able to grow substantially over time as the top banks have less than 60% market share. The large state banks (BNI and Mandiri) will remain afloat as a matter of policy, but are long shots to generate value and return on invested capital over a full cycle, dependent as they are on high-cost liabilities and corporate/SOE lending. Universal and Bali have valuable, although tarnished, franchises, and may conceivably find new life under foreign bank purchasers; otherwise we look for them to be consolidated with other banks in the top ten within 12 months. Neither of the two appears to be viable as a stand-alone bank. 6 September 27, 2001 Indonesian Banks: Accidental Stars Industry Growth and Prospects Loan Growth Has Begun To Recover… Loan growth has returned to positive territory, although the banking system is considerably smaller in terms of total assets than it was pre-crisis. However, the listed private banks are moving ahead smartly with the business of extending credit. Importantly, we see no signs as yet that banks are lending imprudently or failing to properly classify new loans as necessary(cid:1)although we advise continued vigilance as this is the major risk of investing in the financially strong Indonesian banks. Figure 4: Indonesian Commercial Bank Loan Growth, YoY Change 100% 80% 60% 40% 20% 0% -20% -40% -60% 1 1 2 2 3 3 4 4 5 5 6 6 7 7 8 8 9 9 0 0 1 9 9 9 9 9 9 9 9 9 9 9 9 9 9 9 9 9 9 0 0 0 Mar- Sep- Mar- Sep- Mar- Sep- Mar- Sep- Mar- Sep- Mar- Sep- Mar- Sep- Mar- Sep- Mar- Sep- Mar- Sep- Mar- Source: Bank Indonesia Note that total or gross loans are not a good indicator of real growth, as they are subject to the distorting effects of loan write-offs(cid:1)which we generally consider beneficial. Looking only at our statistic of performing (Category 1) loans, we see that growth at the more distressed banks in our coverage universe improves markedly. Figure 5: Loan Growth: Lehman Brothers Covered Universe AVG BCA Lippo Panin Loan Growth FY2000 Total Loans 95% -3% 15% 35% Performing Loans 130% -4% 145% 90% Loan Growth 1Q01 (YoY) Total Loans 129% -2% 8% 45% Performing Loans 140% 18% 95% 84% Loan Growth 2Q01 (YoY) Total Loans 105% -7% -29% 23% Performing Loans 97% 20% -26% 30% Loan-to-deposit Ratio 12% 20% 53% 28% Source:Company reports; Lehman Brothers estimates September 27, 2001 7 Indonesian Banks: Accidental Stars …As Interest Rates Have Stabilized Generally declining and stable interest rates over the past two years have contributed to the industry’s increased vigor. Although rates have crept up over the past two quarters on political uncertainty, this issue appears to be resolved satisfactorily, at least for the moment. We project a decline in benchmark SBI rates of 500-600 bp by 2004, which should stimulate loan growth further. Figure 6: 3-Month SBI Rate: 10/98—9/01 70 60 50 40 30 20 10 0 8 8 9 9 9 9 9 9 0 0 0 0 0 0 1 1 1 1 9 9 9 9 9 9 9 9 0 0 0 0 0 0 0 0 0 0 Oct- Dec- Feb- Apr- Jun- Aug- Oct- Dec- Feb- Apr- Jun- Aug- Oct- Dec- Feb- Apr- Jun- Aug- Source: Bloomberg 8 September 27, 2001 Indonesian Banks: Accidental Stars Figure 7: Aggregate Loan Growth and Loan to Deposit Ratio: 1991-2001 Loan Growth IDR Bil, YoY %, YoY Loans to Deposits 1991 15,847 16.34% 163% 1992 10,093 8.95% 145% 1993 27,353 22.25% 143% 1994 38,609 25.69% 151% 1995 45,731 24.21% 144% 1996 58,310 24.85% 136% 1997 85,213 29.09% 160% 1998 109,292 28.90% 117% 1999 (262,293) -53.81% 48% 2000 43,867 19.48% 51% Jun-01 66,198 27.57% 55% Source: Bank Indonesia We anticipate that loan growth will continue to be strong for our universe of banks, mainly due to them gaining market share and the normalization of the economy, rather than because of strong economic growth. After write-offs and workouts, Indonesia has commercial bank credit outstanding of only 21% of GDP, well below the average level in the region, leaving plenty of room for expansion, even despite low economic growth. We project average growth in performing loans of 33% in FY2001, 13% in FY2002, 20% in FY2003, and 18% in FY2004. September 27, 2001 9 Indonesian Banks: Accidental Stars Figure 8: Total Commercial Bank Credit to GDP: Regional and Global Comparison (cid:21)(cid:19)(cid:19)(cid:17)(cid:19)(cid:8) (cid:20)(cid:27)(cid:19)(cid:17)(cid:19)(cid:8) 7RWDO(cid:3)FUHGLW(cid:3)DV(cid:3)D(cid:3)(cid:8)(cid:3)RI(cid:3)*’3 (cid:20)(cid:25)(cid:19)(cid:17)(cid:19)(cid:8) (cid:20)(cid:23)(cid:19)(cid:17)(cid:19)(cid:8) &RQVXPHU(cid:3)FUHGLW(cid:3)DV(cid:3)D(cid:3)(cid:8)(cid:3)RI(cid:3)*’3 (cid:20)(cid:21)(cid:19)(cid:17)(cid:19)(cid:8) (cid:20)(cid:19)(cid:19)(cid:17)(cid:19)(cid:8) (cid:27)(cid:19)(cid:17)(cid:19)(cid:8) (cid:25)(cid:21)(cid:17)(cid:20)(cid:8) (cid:25)(cid:23)(cid:17)(cid:25)(cid:8) (cid:24)(cid:26)(cid:17)(cid:25)(cid:8) (cid:25)(cid:19)(cid:17)(cid:19)(cid:8) (cid:23)(cid:27)(cid:17)(cid:20)(cid:8) (cid:23)(cid:27)(cid:17)(cid:21)(cid:8) (cid:23)(cid:27)(cid:17)(cid:23)(cid:8) (cid:23)(cid:21)(cid:17)(cid:21)(cid:8) (cid:23)(cid:19)(cid:17)(cid:19)(cid:8) (cid:21)(cid:23)(cid:17)(cid:19)(cid:8) (cid:21)(cid:19)(cid:17)(cid:19)(cid:8) (cid:24)(cid:17)(cid:25)(cid:8) (cid:28)(cid:17)(cid:25)(cid:8) (cid:20)(cid:17)(cid:23)(cid:8) (cid:19)(cid:17)(cid:19)(cid:8) 3KLOLSSLQHV ,QGRQHVLD 7KDLODQG RXWK(cid:3).RUHD 0DOD\VLD 7DLZDQ 6LQJDSRUH -DSDQ $XVWUDOLD +RQJ(cid:3).RQJ 86$ 6 Source: Central banks; CEIC; Lehman Brothers estimates Figure 9: Total Commercial Bank Credit to GDP: Regional and Global Comparison 7RWDO(cid:3)FUHGLW(cid:3) &RQVXPHU(cid:3) &RQVXPHU(cid:3) DV(cid:3)D(cid:3)(cid:8)(cid:3)RI(cid:3) FUHGLW(cid:3)DV(cid:3)D(cid:3)(cid:8)(cid:3) ORDQV(cid:3)DV(cid:3)D(cid:3)(cid:8)(cid:3) *’3 RI(cid:3)*’3 RI(cid:3)7RWDO(cid:3)ORDQV ,QGRQHVLD (cid:21)(cid:20)(cid:17)(cid:21)(cid:8) (cid:24)(cid:17)(cid:25)(cid:8) (cid:21)(cid:25)(cid:17)(cid:21)(cid:8) 3KLOLSSLQHV (cid:23)(cid:20)(cid:17)(cid:21)(cid:8) (cid:20)(cid:17)(cid:23)(cid:8) (cid:22)(cid:17)(cid:21)(cid:8) 6RXWK(cid:3).RUHD (cid:25)(cid:20)(cid:17)(cid:27)(cid:8) (cid:21)(cid:23)(cid:17)(cid:19)(cid:8) (cid:22)(cid:27)(cid:17)(cid:27)(cid:8) 7KDLODQG (cid:28)(cid:20)(cid:17)(cid:23)(cid:8) (cid:28)(cid:17)(cid:25)(cid:8) (cid:20)(cid:19)(cid:17)(cid:24)(cid:8) $XVWUDOLD (cid:20)(cid:20)(cid:20)(cid:17)(cid:20)(cid:8) (cid:24)(cid:26)(cid:17)(cid:25)(cid:8) (cid:24)(cid:20)(cid:17)(cid:27)(cid:8) 6LQJDSRUH (cid:20)(cid:20)(cid:25)(cid:17)(cid:19)(cid:8) (cid:23)(cid:27)(cid:17)(cid:21)(cid:8) (cid:23)(cid:20)(cid:17)(cid:25)(cid:8) 7DLZDQ (cid:20)(cid:21)(cid:20)(cid:17)(cid:26)(cid:8) (cid:23)(cid:27)(cid:17)(cid:20)(cid:8) (cid:22)(cid:28)(cid:17)(cid:24)(cid:8) -DSDQ (cid:20)(cid:21)(cid:24)(cid:17)(cid:19)(cid:8) (cid:23)(cid:27)(cid:17)(cid:23)(cid:8) (cid:22)(cid:27)(cid:17)(cid:26)(cid:8) 0DOD\VLD (cid:20)(cid:22)(cid:26)(cid:17)(cid:20)(cid:8) (cid:23)(cid:21)(cid:17)(cid:21)(cid:8) (cid:22)(cid:19)(cid:17)(cid:27)(cid:8) +RQJ(cid:3).RQJ (cid:20)(cid:23)(cid:23)(cid:17)(cid:27)(cid:8) (cid:25)(cid:21)(cid:17)(cid:20)(cid:8) (cid:23)(cid:21)(cid:17)(cid:28)(cid:8) 86$ (cid:20)(cid:27)(cid:21)(cid:17)(cid:19)(cid:8) (cid:25)(cid:23)(cid:17)(cid:25)(cid:8) (cid:22)(cid:24)(cid:17)(cid:24)(cid:8) Source: Central banks; CEIC; Lehman Brothers estimates. 10 September 27, 2001