- An economic recovery in 2016 will likely lead to sequential recovery in loan and deposit growth. NPL uptrend may decelerate, peaking by 1H16.
- Room for at least 25bp policy rate cut next year as inflation remains benign, translating into positive margin outlook for 2016.
- Liquidity, already improving as government spending accelerates and IDR stabilises, should be boosted further by policy easing and reforms.
- The sector currently trades at 2x P/B (at -1SD) below its 10Y mean of 2.3x .
- Maintain Overweight. BBRI and BBNI are our top picks going into 2016.
Economic recovery in sight
The economy seems to have bottomed in 2/3Q15 at 4.7%, setting a base for recovery going into 2016. Recent data e.g. rebound in cement sales, stabilising vehicle demand, rebounding consumer confidence and improving business sentiment on the back of aggressive reforms hint that 4Q15 GDP growth might test the 5% mark again, lifting sentiment if it does. That might push 2016 GDP growth to above 5%, led by government spending, followed by a pick-up in fixed asset investment and consumption eventually.
Banks as a proxy for economic recovery
An economic recovery will translate into higher loan and deposit growth outlook, in our view. We forecast 11% yoy loan growth in 2015 and a slight pick-up to 13% yoy in 2016. Concurrently, we forecast deposit growth to be around 12% this year (M2 growth was at 10% in 10M15) before rising to 13-15% next year on the back of an improvement in the current account and steep increase in government spending.
Policy rate cut potentiality positive for margin
The significant improvement in CAD and inflation through to end-2015 had sparked talks on potential rate cuts. IDR stability remains a key consideration, in our view, hence BI would likely wait for FFR hike outcome to make its move. Given the benign inflation outlook and large real rate spread, we believe there is room for BI to its lower policy rate by 25bp to 7.25%, probably as early as end-2015. A lower rate means higher NIM potential for banks given the high LDR situation.
Asset quality remains the biggest overhang
Asset quality has yet to show any improvement (8.5% NPL+SML in 9M15 up from 6.3% in 2014), though the rate of deterioration has subsided. We expect it to get worse before improving and peaking in 2Q16, aided by early restructuring initiatives. This is provided that the economy starts recovering in 4Q15 and the IDR stabilizes. Risks to our base case are slower-than-expected recovery and IDR volatility picking up again.
Share prices tend to bottom ahead of peak NPL
The bank’s current valuations of 2x P/B (at -1SD of its 10Y mean of 2.3x) priced in 14.2% ROE vs. its average of 15.1%. Past cycles suggest that share prices bottomed 5 months before the NPL cycle peaks (2005 and 2009). Main catalyst will be declining trend in both NPL and SML formation and stronger than expected economic growth.