Banks, Ex-S&L Indonesian Banks: How to anchor NPL expectations amid massive loan restructuring?

We don't think credit cost for Indonesian banks will peak until 2021E. In 2020E/21E, we expect a combined 340bp excess credit cost (vs historical 10-year average) to cover for COVID-19 new NPL, compared to consensus of 140bp.

20 Jul 2020

Consensus vs. UBS credit cost (bp) big 4 banks

Source: Company data, Reuters, UBS estimates

This column chart shows UBS estimates and consensus estimates of credit cost for the big 4 banks for 2020 through 2022.

We are less concerned on national service, but asset-quality trend a worry

After performing an 8% new nonperforming loan (NPL) stress test on 110 banks, we found the capital need to be less than a third of the net assets of the resolution authorities. While we estimate that the big 4 banks could survive without additional capital, we think asset quality trend remains the biggest earnings risk next year. Our analysis of the short-term medium-term note (MTN) market (spike in NPL to 4.5% in May after practically zero for the past 10 years) indicates asset quality deterioration.

Two new data sets to anchor NPL expectations

An unprecedented 20-30% loan restructuring masked banks' NPL formation. However, the NPL spike to 4.5% in the MTN market after being near zero for the past 10 years, and the fact that net issuance year-to-date has shrunk to almost zero despite record low interest rates, suggests that all is not well on the asset-quality side. Meanwhile, our survey of the cash-flows at 420 listed corporates reveals a deepening of the negative spread between EBIT RoIC and lending rate, which in the past correlated strongly with rising loans-at-risk in domestic banks.

Risk of national service less worrying

The new crisis management protocol and anchor bank program were thought to introduce additional risk to investing in the big banks. However, we are not worried about this for several reasons: Our stress test of up to 8% new NPL formation suggests the sector would need Rp43tn of new capital, which is within the budget of Deposit Insurance Corporation (LPS). Recent rule changes also position the Ministry of Finance (MoF) and LPS funds as the liquidity providers for weak banks. We are now also more aware of the legal rigidity that state-owned enterprise (SOE) banks consider before deciding to help another bank.

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