Indonesian Banking Sector Analysis: Key Insights and Top Picks

Broker Name: UOB Kay Hian

Date of Report: Friday, 15 November 2024

Overview

The Indonesian banking sector is navigating through a period of uncertainty concerning rate cuts, government spending, and market competition. With Trump’s economic policies potentially leading to higher inflation and the Fed possibly slowing down rate cuts in 2025, the dynamics of the banking sector are poised for significant changes. Higher government spending and robust loan growth are expected to support the money supply growth, while high Loan-to-Deposit Ratios (LDR) indicate stiff competition in low-cost funding. Despite the high Cost of Funds (CoF), banks are expected to face less competition in the loan market, enabling them to manage their Net Interest Margins (NIM) effectively. This sector update maintains an OVERWEIGHT rating, with BBCA and BMRI as the top picks.

Rate Cut Outlook

Trump’s economic policies, which include deregulation, lower domestic taxes, and increased tariffs, could create an inflationary environment, leading the Fed to slow down rate cuts. Given the strong correlation between the Bank Indonesia (BI) rate and the Fed rate, BI is expected to follow the Fed’s decisions to support the rupiah. Additionally, Prabowo’s plans for higher government spending, with net government bonds issuance reaching Rp642 trillion and around Rp800 trillion maturing in 2025, may require higher yields to attract investors. This could result in less aggressive rate cuts than anticipated. Nevertheless, economists expect a 100bp rate cut in 2025, with 50bp cuts in the first half of the year.

Higher Government Spending and Improved Liquidity

The industry’s LDR stood at 87% in August 2024, indicating stiff competition in low-cost funding. However, money supply (M2) growth recovered from a low of +3.5% year-on-year (yoy) in December 2023 to 7.2% yoy in September 2024, supported by strong loan growth. Increased government spending and robust loan growth are expected to sustain M2 growth at high single digits in 2025, allowing the industry to achieve its loan growth target of 11-13%. Despite high reserve requirements and strong loan growth, liquidity management tools to deposit ratio (AL/DPK) were high at 25.4% in September 2024, with bonds held by banks reaching 19% of total assets.

Loan Market Competition and Lending Rates

Due to rate hikes of 275bp between August 2022 and April 2024, the CoF increased by over 100bp, one-month JIBOR and time deposit rates rose by over 200bp, while lending rates only expanded by 30bp. Market competition among big banks aiming to solidify market share is believed to be a factor for the smaller increase in lending rates. As pressure on CoF persists, banks are expected to face less intense competition in the loan market, keeping lending rates stable. Bank Negara Indonesia (BBNI) posted a loan yield improvement in 3Q24, while Bank Mandiri’s (BMRI) loan yield remained stable quarter-on-quarter. Bank Central Asia (BBCA) indicated during its 3Q24 earnings call that it expects competition to be less intense and plans to maintain its lending rates. As of September 2024, the lending rate stood at 9.24%, while the 10-year Indonesia government bonds and one-month JIBOR rates were at 6.44% and 6.66%, respectively.

Top Picks: BBCA and BMRI

Despite the uncertainty of rate cuts in 2025 and liquidity tightening, the sector maintains an OVERWEIGHT rating. Investors are advised to focus on big banks with strong deposit franchises, such as BBCA and BMRI. These banks have the best Current Account and Saving Account (CASA) franchises among the Big Four banks, which is reflected in their CASA ratios. This gives them better opportunities to manage their NIM. Government policies that boost social welfare are expected to benefit State-Owned Enterprise (SoE) banks.

Company Analysis

Bank Central Asia (BBCA)

Recommendation: BUY

Share Price: Rp10,100

Target Price: Rp12,000

BBCA is positioned as a top pick due to its strong CASA franchise, which enables it to manage its NIM effectively. The bank expects less intense competition in the loan market and plans to maintain its lending rates. As of September 2024, BBCA’s lending rate stood at 9.24%. The bank’s current Price-to-Book (P/B) ratio is 4.3, with an average of 4.1, reflecting a +0.7SD. BBCA has shown a year-to-date (Ytd) return of 7.4%, a month-to-date (Mtd) return of -1.5%, and a month-on-month (MoM) return of -3.8%. Since its high in September 2024, the bank’s share price has corrected by -7.8%.

Bank Mandiri (BMRI)

Recommendation: BUY

Share Price: Rp6,375

Target Price: Rp8,120

BMRI is another top pick due to its strong CASA franchise, which allows it to manage its NIM effectively. The bank’s loan yield remained stable quarter-on-quarter in 3Q24. BMRI’s current P/B ratio is 1.9, with an average of 1.7, reflecting a +0.7SD. BMRI has shown a Ytd return of 5.4%, an Mtd return of -4.9%, and a MoM return of -7.9%. Since its high in September 2024, the bank’s share price has corrected by -14.4%.

Bank Negara Indonesia (BBNI)

Recommendation: BUY

Share Price: Rp4,950

Target Price: Rp6,560

BBNI is improving its CASA franchise, but its high LDR position might put it at a disadvantage compared to its peers. The bank posted a loan yield improvement in 3Q24. BBNI’s current P/B ratio is 1.1, with an average of 1.0, reflecting a +0.3SD. BBNI has shown a Ytd return of -7.9%, an Mtd return of -5.7%, and a MoM return of -8.8%. Since its high in September 2024, the bank’s share price has corrected by -14.7%.

Bank Tabungan Negara (BBTN)

Recommendation: BUY

Share Price: Rp1,305

Target Price: Rp1,740

BBTN is positioned as a BUY despite its smaller market capitalization compared to the other banks. The bank’s current P/B ratio is 0.5, which is in line with its average. BBTN has shown a Ytd return of -21.4%, an Mtd return of -6.3%, and a MoM return of -8.2%. Since its high in September 2024, the bank’s share price has corrected by -18.6%.

Valuation and Recommendation

Trump’s victory led to a sell-off in emerging markets and a shift towards US equities, causing a sharp correction in Indonesian banks. His economic policies are expected to benefit American companies, leading the Big Four banks to trade close to their five-year historical forward P/B mean. During the US-China trade war in 2018, the Big Four banks bottomed at -1SD.

If there are signs of rate cuts, a better liquidity environment, or stronger conviction regarding rate cuts, investors are advised to switch to BBNI and BBRI. Government programs and policies that boost social welfare are expected to benefit SoE banks. BBRI has a strong retail deposit franchise but is expected to focus on asset quality in the first half of 2025. BBNI is improving its CASA franchise, but its high LDR position might put it at a disadvantage compared to its peers.

Earnings Revision and Risks

There are no changes to the earnings estimates. Since the 3Q24 earnings call, consensus did not make any significant earnings revisions for 2024 and 2025. Consensus forecast combined net profit growth of 10.0% for the Big Four banks, while a net profit growth of 10.4% is expected in 2025. The biggest downside risk to earnings forecasts is the uncertainty of rate cuts. The combination of tight liquidity and high reference rates could harm Indonesia banks’ NIM.

Other risks include: uncertainty over rate cuts, liquidity tightening, weaker purchasing power, weak government spending, intense competition in the funding and loan markets, and changes in banks’ top management teams.

Industry Data and Projections

The industry data as of September 2024 shows that the BI rate stands at 6.00%, with lending rates at 9.24%, and one-month deposit rates at 4.77%. The M2 money supply growth is projected to remain at high single digits in 2025, supported by increased government spending and strong loan growth. The LDR is at 86.8%, indicating a competitive environment in the low-cost funding market. Non-Performing Loans (NPL) ratio is at 2.26%, showing a stable asset quality in the sector.

Conclusion

The Indonesian banking sector is poised for significant changes in 2025, with uncertainties surrounding rate cuts and liquidity tightening. However, big banks with strong deposit franchises, such as BBCA and BMRI, are well-positioned to manage their NIM effectively. Investors are advised to focus on these banks, given their strong CASA ratios and better opportunities to manage their NIM. Government policies that boost social welfare are expected to benefit SoE banks, making them attractive investment options in the current market environment.