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Analysis: Market strategy amid policy risks
In the past week, the government, through the Vice President as well as various ministers, has expressed the need for Indonesian banks to lower both deposit and interest rates, with the Financial Services Authority (OJK) planning to come up with incentives (e
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n the past week, the government, through the Vice President as well as various ministers, has expressed the need for Indonesian banks to lower both deposit and interest rates, with the Financial Services Authority (OJK) planning to come up with incentives (e.g. lower tax rates) for banks which can decrease their net interest margins (NIMs) going forward.
Our view on this issue is one of ambivalence. While based on textbook theory, the government's recent move to intervene in both interest rates and NIMs could lead to financial repression; the existing Indonesian banking structure is oligopolistic in nature with dominant price leadership. That said, a failed market mechanism caused by a monopoly does require government intervention to correct.
Failure to do so may lead the banking system as well as the economy to continue performing sub-optimally.
At this stage of the market cycle, the question for the Indonesian banking sector should be the proper mechanism and the extent of government intervention that will bring about greater market efficiency.
However, we would like to warn that without proper management and an adjustment period, massive layoffs and deterioration in property rental prices could occur as banks shift to IT and M&A/branch closures, in pursuit of efficiencies.
Furthermore, with lower deposit rates, the Indonesian middle- to upper-income population (note that mid to low earners do not have savings) would lose out. However, on the flip side, the overall middle class should benefit from lower borrowing rates and higher purchasing power from stronger economic growth, helped by lower lending rates.
With NIMs for prime corporate customers at 2 to 2.5 percent, banks will be forced to lower margins of project, consumer and commercial (SMEs) loans. While this will generally be negative for banks, the overall economy should benefit from greater loan volumes from this lower trend in NIMs (i.e. assuming banks do not decide to place their funds in other financial instruments such as 10-year government bonds, which are still yielding around 8 percent.)
Going forward, in order to offset the adverse impact from lower NIMs, we expect banks to be forced to be creative in generating higher fee-based income (sales of mutual funds and insurance, for example). Based on our sensitivity analysis, for every 100bp contraction in NIMs, the sector should see 40 percent lower average net earnings (Table 1).
Over the mid-term, lower lending rates and higher economic growth should lead to a lower weighted average cost of capital (WACC), allowing for an overall market re-rating. Nevertheless, our conversations with both foreign and local funds last week point to one universal conclusion: The trimming of banking stocks (particularly on market rebounds) as fund managers are now concerned about possible faster-than-expected NIM contractions.
Most funds we spoke to believe that this process will be gradual, although NIM pressure will undoubtedly materialize. Some local fund managers expect that the OJK will 'punish' banks without proper plans to lower future NIMs through approval sanctions (e.g. product launches, branch openings).
Given these recent headwinds for Indonesian banks, we are taking all banks out of our top buy list. Looking ahead, we expect the consumer, telcom and construction sectors to experience greater weightings in fund managers' portfolios. It is worth noting that currently, Indonesian banks only account for 25 percent of total market cap of the Jakarta Composite Index (JCI), down from 30 percent previously, surpassed by consumer staples at 35 percent.
At this stage, HM Sampoerna's (HMSP) market cap is already equal to those of Bank Mandiri (BMRI) and Bank Rakyat (BBRI) combined while Bank Central Asia's (BBCA) market cap is equivalent to Unilever's (UNVR) and Bank Negara Indonesia's (BBNI) to Indofood Consumer Branded Products' (ICBP). The market cap of the four biggest banks is equalled by three consumer companies.
As bank holdings are trimmed, we foresee continued upward re-ratings for consumer and construction counters, despite their current high valuations. That said, despite headwinds for Indonesian banks, we believe that the JCI should remain relatively well supported, and we retain our 2016 index target at 5,100.
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The writer is the Senior Associate Director, Head of Corporate Strategy and Research, Bahana Securities
