BTN - Rp1,230 - UNDERPERFORM

Heightened regulatory risk

A pick-up in demand in the property sector benefits BBTN which has been providing mortgages since its establishment in 1976. However, having large exposure to the subsidized mortgage market doesn’t give the bank an edge as regulatory risk is imminent. Changes in regulation and an adjustment in the subsidized rate may negatively affect the bank’s financial performance. Although we expect reliance on subsidized mortgages to continuously decline, pressure on NIMs are inevitable this year. We reinitiate with underperform.
Prone to regulatory risk
Even though BBTN’s reliance on subsidized mortgages has fallen from 46% in 2008 to 41% in Sep11, they still make up the majority of the bank’s loan portfolio. Therefore, any regulatory changes related to subsidized mortgage rates will affect the bank’s performance. The Housing Ministry’s intention to lower the subsidized mortgage rate to 5% could put pressure on the bank’s margins. Though not yet final, lower NIMs are inevitable in our view.
Better NPLs going forward
The good news: the new subsidized mortgage scheme will promote lower NPLs. This is because under the new scheme, mortgage rates will remain fixed for the whole tenor. Furthermore, an improved loan acquisition process and monitoring will also serve as a support for lower NPLs in the future. We are projecting 2.8% NPLs in 12CL.
Funding will remain a challenge
BBTN’s existing network limits its ability to raise funds. Meanwhile, its LDR at 112% is among the highest in the sector. BBTN, therefore, has been aggressively opening kiosks for the past 2 years, the benefits of which are expected to materialize this year. Positive catalyst? Indonesia’s investment grade rating will help reduce the marginal cost of any future bond issuances.
Reinitiate with underperform rating
Pressures to lower lending rates have been widely echoed among all government bodies, leaving banks with exposure to government programs vulnerable. We also see tightening competition in the mortgage segment which will pressure yields on commercial mortgages. We foresee a decline in NIM from 5.5% in 11CL to 5.1% this year, making the bank’s profitability outlook less promising. We reinitiate our coverage with an underperform rating.

Heightened regulatory risk
Improved loan booking is expected in 4Q11
BBTN experienced slower loan growth in 9M11 (+21% YoY vs 29% YoY in 9M10). The management highlighted problems encountered in the field, particularly on subsidized mortgages post implementation of a new subsidized mortgage scheme in Oct10.
Under the new scheme, potential borrowers are required to have a Tax ID and Tax slip. For lower income earners who are the main target of subsidized mortgages, obtaining a tax ID and tax slip are big issues. Consequently, the budget allocated by the government for subsidized mortgages could not be fully utilized.

The government budget was Rp2.7tn for subsidized mortgages in 2010, Rp3.5tn in 2011 and will be another Rp4.5tn this year. Assuming the amount funded by the government remains the same, i.e 60% of the total mortgage, the total funds available for subsidized mortgages will reach Rp4.5tn, Rp5.8tn and Rp7.5tn respectively.

Until end Sep11, BBTN only managed to disburse Rp3.7tn of subsidized mortgages from the total Rp6tn targeted for the year. We expect higher disbursement in 4Q11 as our latest discussion with the management revealed that the acceptance level for the new scheme has improved. Lower income people are becoming more aware about the tax requirement.
Lower contribution from subsidized mortgages
Even though the contribution from subsidized mortgages has trended down for the past two years, it remains the largest contributor to total loans for the bank. As of Sep11, it represented 41% of total loans.

BBTN targets subsidized mortgages to reach Rp7.5tn in 2012. Currently, the average loan size for subsidized mortgages is Rp50mn-55mn/debtor.
Meanwhile, non-subsidized mortgages grew by 23% CAGR over the past three years, and represented 30% of total loans as of Sep11. Subsidized and non-subsidized mortgages combined, BBTN claims the highest market share of mortgages in the system.

Vulnerable to regulatory changes
As subsidized mortgages still account for most of the total loans, the bank is prone to any regulatory changes. Press has quoted the Housing Ministry’s plan to reduce the subsidized mortgage rate to 5% from the current 8.15%-8.5% for landed residential. However, this is not yet final.
Banks involved in this program (estimated around 20 banks and BBTN has 99% market share in subsidized mortgages) are required to submit their proposal stating their proposed mortgage rate based on their overhead costs and cost of funds.
BBTN is proposing a higher share from the government (from the current 60%), so the bank will be able to offer lower rates without sacrificing margin. However, the outcome is uncertain, meaning regulatory risk will remain.
Meanwhile, new bookings for subsidized loans has been stopped since 11 Jan12 until the MoU between the Ministry of Housing and banks is reached (expected by end of this month). To deal with this, BBTN is currently promoting new mortgage rate for non-subsidized mortgage, i.e 9% p.a for above Rp350mn exposure and 9.5% for below Rp350mn (from 10-12% previously).
Lower NPLs expected
NPLs from subsidized mortgages are usually higher than that from non-subsidized mortgages. In the past, this has been particularly noticeable in the fourth year of the subsidized mortgage when the rates have climbed up (mortgage rates stay at 7% in year 1-3, increase to 10.5% in year 4, 11% in year 5-6, and float thereafter).

This scheme has been scrapped and replaced by a fixed mortgage rate for the whole tenor. We therefore expect better NPLs going forward. Moreover, the bank has also adopted an improved loan origination and monitoring process since April 2011, which leverages better IT infrastructure. We expect the bank’s NPLs to be at 2.8% in 12CL.
Funding will remain a challenge
There are 2 issues related to the bank’s funding: (1) the bank’s high LDR, which creates concern over the bank’s liquidity and loan growth in the future (2) the bank’s high cost of funding, which reflects its difficulties in generating funding at low cost.

Note however, that different from other banks, where 90% of funding comes from deposits, BBTN’s deposits only accounts for 81% of total funding. The bank has relied on other sources of funding like bonds and borrowings (including assets securitization) to finance its growth. The problem is this type of funding has not been cheap for the bank. The average cost of bonds and borrowings were 10.9% and 7.2%, respectively in 9M11.

Furthermore, the bank’s deposit mix has been biased toward the high cost Time Deposits, which is easy to understand considering the bank’s limited network. Consequently, the bank has had the highest cost of funding compared to other banks in CLSA’s coverage.

BBTN addressed this issue by expanding and building more kiosks. The bank opened 111 kiosks in 2010, 205 kiosks in 2011 and will open another 100 kiosks in 2012. At end Dec11, the bank managed to obtain a total Rp3tn worth of deposits from its kiosks, representing around 5% of total funding. With the opening of more kiosks, we expect funding to improve in the future, both in terms of growth and composition. We expect deposits to grow by 20% in 12CL vs 18% in 11CL.

Meanwhile, we also expect lower marginal cost of borrowings from the bank’s future bond issuances post Indonesia’s investment grade rating. The latest bond issuance was in Jun2011 raising a total of Rp1.3tn. The coupon rate and current yield for this bond is 9.5% and 9.1%, respectively. This bond will be due in 2021.
Lower RWA is applied
Starting early this year, the new risk weighted assets is applied for mortgages as follows: (1) 35% RWA for mortgages with loan to value of 70%, (2) 40% RWA for mortgages with loan to value of 70-80% and (3) a higher 45% RWA for mortgage with LTV above 80%.
Our discussion with the management revealed that the impact for the bank will be neutral as currently most of the bank’s mortgages have loan to value of between 70-80%.

Reinitiate with underperform rating
Pressure to lower lending rates has been widely echoed at all government bodies, making banks with exposure to government programs difficult to avoid NIM compression. We therefore foresee lower NIM for the bank this year, making the bank’s profitability outlook less promising.

Meanwhile, we also forecast the bank’s profit growth to not be adequate enough to support strong loan growth for the next three years. Assuming net profit of Rp1.0tn in 11CL and CAR remaining at 13%, the bank can only book additional loans of Rp7.7tn in 12CL with RWA of 40%. This will trigger the need for capital-raising in 2013.

Using the Gordon Growth Model with 13% sustainable ROAE, 30% dividend payout ratio and 16% required rate of return, we arrived at Rp1,300 as our Target Price. We reinitiate the stock with underperform recommendation.

source: CLSA dated 16 January 2012