Market Outlook 2017: Banking sector

Waiting for loan growth rebound

In June 2016, loans of banking industry grew by 8.8% YoY while deposit only grew by 3.6% YoY during the same period, both were considerably slower than at the end of 2015. The slowing down of loans and deposit growth is a structural trend that has begun since 2011. Nevertheless, a trend must stop somewhere and we expect that loans growth could start to accelerate in 2017 on the back of higher economic growth and central’s bank consistent expansive monetary policy. BI expects industry loans to grow by 11% YoY in 2017, and we also believe that loans to grow by 11.0% YoY in 2017. 

Expansive monetary policy supports margin

BI cut 7-day RR rate by 25 bps to 5.0% in September 2016, and we expect that the central bank still has ample room to further decrease rate further and continuing its expansionary monetary policy for several reasons. First, inflation is contained where deflation was recorded in August 2016.  Secondly, fiscal ability to help boosting economic growth is quite limited as tax shortfall forces government to tighten the national budget. Last but not least, Fed is expected to continue its relatively dovish stance. As a result, we believe that NIM would be relatively stable. We estimate will be at 5.60% in 2016 and decreasing slightly to 5.50% in 2017 as lenient monetary policy will slowly abate.    

The bottom is near for asset quality

Upward trend of NPL that has been started since 2013 could find its peak in 2016. Once the NPL peak is reached, banks can stop to aggressively grow provision expense. The peak of NPL will coincide with the start of acceleration of loans growth that we believe would happen in 4Q16 or 1Q17. All in all, the pace of asset quality recovery of Indonesian banks depends on several factors such as economic growth acceleration and the success of banks’ restructuring program.  NPL could be back below 3% in 2017 where 2.8% NPL at the end of 2017 is quite conservative in our view.

Bottom line growth to accelerate

The quite erratic nature of bank’s bottom line growth is caused mainly not by its top line as net interest income is relatively stable historically, but by NPL cycle where banks have to respond by managing its provision expense. As we expect the asset quality bottom is near, we also expect that banks will start to slow down provision expenses growth in 2017, resulting in acceleration of bottom line.

How the market values banks overtime?

For the last decade, the average PBV for Book IV banks in Indonesia (as our proxy for banking industry) is 2.8x. The current PBV of 2.2x was slightly lower than -1 stdev of 2.3x, low on a historical perspective. We expect that market valuation on banks could improve reverting towards the mean once the system’s NPL has found the bottom.

Our top picks

We choose BBNI for Book IV bank and BJBR for Book III bank top picks in 2017. We like BBNI for its ability to poach customers in 2016 where the bank’s loans growth surpasses its peers during the year and we expect that the bank’s loans growth can continue to beat industry’s growth in 2017. Furthermore, there is a possibility that the bank’s NPL could reach its peak in 3Q16 or 4Q16 and asset quality getting better throughout 2017 (we expect 2.5% NPL to be reached at the end of 2017), enabling to the bank to aggressively cut provision expense further. Meanwhile, BJBR’s is without doubt a star performer among banks in 2016 with its trend-bucking NPL decrease, strong loans growth and margin expansion. Its seemingly rich market valuation compares to the past is justified with ROE consistently above 20% in 2016 and we expect this to continue in 2017 onwards.