| 2013 | 2014 | ||||||
| Price: | 14.30 | EPS | $0.00 | $0.00 | |||
| Shares Out. (in M): | 100 | P/E | 9.0x | 8.0x | |||
| Market Cap (in $M): | 17,500 | P/FCF | 0.0x | 0.0x | |||
| Net Debt (in $M): | 0 | EBIT | 0 | 0 | |||
| TEV (in $M): | 0 | TEV/EBIT | 0.0x | 0.0x | |||
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Remarks on the Indonesian Economy and Financial System
Indonesiahas about 250 million people, most of which live on two large islands: Java (60%), andSumatra(25%). Nominal per capita GDP is low at around $3,500. However, after recovering from the Asian financial crisis, GDP growth has been quite steady at around 6% – exceeding 4% even during the recent financial crisis. The urbanization rate is 44%, and seems to have increased at about 0.5% per year in recent years. Java (and especiallyJakarta) is richer and more urbanized than other islands. Total GDP is around USD$900bn nominal. The economy is highly informal – estimates range from 50% to 70%.
We must understand the Indonesian financial system in context of the Asian financial crisis which probably hitIndonesiaharder than any other country. It took until 2004 to recover the real GDP lost, and almost every bank in the country needed massive recapitalization.
The financial crisis was caused by:
1) Hot money flows intoIndonesiawhich caused duration and currency mismatches in bank portfolios
2) Massive corruption by Suharto’s family/cronies
3) Many banks were tied to industrial concerns, which raised deposits to lend to themselves
4) The Indonesian central bank was stripped of supervision/enforcement powers by Suharto
As the crisis unfolded, bank NPLs peaked at over 25%. Suharto was ousted. The IMF came in, and the banking sector was recapitalized. This produced several long term benefits for Indonesian banks:
1) The sector was consolidated and supervision became much more effective
2) Banks became more conservative in lending and balance sheet management. The Indo banking sector has some of the highest capital ratios I’ve ever seen.
3) After huge deleveraging in the late 1990s and early 2000s, the entire economy ended up with very low debt levels. At the bottom, the entire commercial banking system had USD$25 billion of loans outstanding!
4) The IMF forced banks to upgrade their technology. The Indonesian banking system seems to be much more technologically advanced thanIndia, for instance.
Today,Indonesiahas a small banking system in relation to its economy, and almost all credit is channeled through banks. Commercial bank assets are maybe 50% of GDP, and loans outstanding are perhaps 33% of GDP. To put this in perspective, this is similar to thePhilippinesandCambodia.ThailandandMalaysialoans outstanding are around 100% of GDP, and most developed countries are well north of 100%.
Despite the small size of the banking system, it’s quite deposit rich (Indonesians have a high savings rate), and NIMs are unusually high. NIMs across the system are 5-6%. This compares to ~3-3.5% in thePhilippines, ~2.5-3% inThailand, and sub 3% inIndia. Returns on assets are generally high as well – north of 3%. In contrast, a top flight Indian bank might have 1.6%. Wells Fargo in theU.S.is about 1.4%. These ROAs mean that banks typically earn decent ROEs despite not having much leverage. Tier 1 capital ratios across the banking system are around 15%.
Starting from a low base, the banking system is extremely fast growing – nominal system assets are probably +20% per year CAGR. That said, this growth scares me less than it would in most other places, because leverage levels in both public and private sectors are fairly low.
A Brief History of Bank Rakyat
Bank Rakyat in the Suharto days was sort of an agricultural cooperative / policy bank. It was used to channel credit to farmers and the rural economy. To facilitate this process, the government caused Rakyat to create ~3,600 small branches throughout the country over several decades. This branch network is at the core of the bank’s franchise today.
In the 1970s, oil prices spiked and the government decided to share the oil wealth with the citizens through a heavily subsidized / guaranteed loan program, channeled thru Rakyat and some other rural cooperatives. (Back in those days, Indonesia exported a lot of oil.) The problem was that nobody had any reasons to collect on these loans (since the government backstopped them), and about 50% of them went bad. When the oil price collapsed in the early 1980s, the government ran out of money. But on the bright side, Rakyat had a ready-made dominant rural credit infrastructure. So Suharto basically told the bank to do something useful, and hopefully make back some of the money it lost.
New management then transformed the bank into a great microlending network – making very small loans ($35 to $500) with almost no documentation, at fairly high interest rates, to farmers, artisans, and small business owners. Rakyat completely changed the incentives at the branch level (big profit sharing based on loan performance) and further expanded the branch network. Surprisingly, the program became extremely successful, with NPL ratios in the very low single digits and very fast growth.
When the Asian Financial Crisis hit, Rakyat was in a better position than most other banks. The microlending NPLs peaked at sub-3%, and deposits actually went UP. This was an amazing figure because the large corporate loan book NPLs peaked at close to 80%. The bank remained independent, though the government had to recapitalize it.
Bank Rakyat Today
Rakyat is the second largest bank inIndonesia, with a low-teens share of the market. It thoroughly dominates rural banking. A 2009 Asian Development Bank study claims Rakyat owns 80% of rural deposits. It also has the most extensive branch network in the country at 8,700 points of presence, 7,000 of which are rural or “rurban”. There are about 30 million customer deposit accounts, nearly 3x as many as the nearest competitor. In short, its business model is unique in Indonesian banking.
The “core” microlending franchise is only about 30% of the loan book today. However, the NIM on this portfolio is very high (15% in 2012, down from 20%+ in past years). Therefore, microlending provides about 45% of the revenues and profits.
The rest of the loan book splits out like this:
This loan book looks very different from the other large Indonesian banks, whose businesses are dominates by medium / large corporates and SOE lending. This makes me like Rakyat more because historically, it’s the medium/larger corporates that have blown up banks, while smaller borrowers send to stay resilient. Aside from the Asian Fin Crisis,Indonesiaexperienced a “mini-crisis” in 2005, when oil prices spiked which forced the government to cut fuel subsidies. Inflation soared to 18% and the rupiah devalued big time. System NPLs peaked at 12%, but the largest bank, Mandiri, which is also a dominant corporate lender, saw NPLs of over 25%. Rakyat NPLs peaked at around 4%.
Even Rakyat’s consumer book is unusual. Systemwide consumer lending is 75% mortgages and motorized vehicles. However, Rakyat’s consumer book is 80% “salary loans” which are personal loans to people who have formal jobs or pensions (the repayments are automatically deducted from wages). The vast majority of these people are government employees or draw govt pensions. Rakyat can originate these loans b/c they are a state bank and various government entities bank with them. If that banking relationship exists, Rakyat gets to make loans to the people on the payroll.
| Loan Mix | 2007 | 2008 | 2009 | 2010 | 2011 | 2012 |
| Micro | 32.6 | 42.8 | 55.1 | 78.0 | 95.3 | 106.8 |
| Consumer | 22.0 | 30.5 | 41.1 | 51.4 | 55.8 | 61.5 |
| Small Commercial | 31.1 | 44.5 | 57.2 | 62.4 | 67.6 | 75.6 |
| Medium | 8.4 | 12.5 | 14.9 | 13.8 | 13.8 | 16.5 |
| Corp | 19.7 | 19.0 | 20.9 | 23.5 | 24.1 | 38.0 |
| SOE | 0.8 | 11.8 | 17.4 | 20.4 | 32.2 | 49.8 |
| Total | 114.6 | 161.0 | 206.6 | 249.6 | 288.8 | 348.2 |
| NPLs by Segment | ||||||
| Micro | 1.2% | 1.0% | 1.4% | 1.2% | 1.2% | 1.1% |
| Consumer | 1.7% | 1.1% | 1.4% | 1.4% | 1.5% | 1.6% |
| Small Commercial | 5.7% | 3.5% | 4.2% | 5.1% | 4.5% | 3.8% |
| Medium | 5.7% | 6.3% | 12.3% | 6.9% | 7.1% | 5.1% |
| SOE | 0.0% | 0.0% | 0.2% | 0.0% | 0.0% | 0.0% |
| Corporpate | 4.6% | 7.3% | 7.8% | 4.6% | 2.3% | 1.0% |
| Total | 3.4% | 2.8% | 3.5% | 2.8% | 2.3% | 1.8% |
My feeling is that side from the consumer / micro lending, Rakyat is very similar to any other Indonesian bank. As you can see, there have been NPL problems in the past. These are the portions of the portfolio that nearly capsized the bank back in the late 1990s.
Despite having pretty good credit metrics, Rakyat is an extraordinarily profitable bank – probably the most profitable I’ve ever seen that is not levered to the gills, and best in class forIndonesia. Tier 1 ratio is 16%.
| Key Ratios | ||||||
| NIM | 10.9% | 10.2% | 9.1% | 10.8% | 9.6% | 8.4% |
| ROA | 4.6% | 4.2% | 3.7% | 4.6% | 4.9% | 5.2% |
| ROE | 31.6% | 34.5% | 35.2% | 43.8% | 42.5% | 38.7% |
| OpEx/Rev | 48.7% | 49.6% | 45.4% | 41.9% | 42.5% | 43.4% |
Moat
Most of the franchise value here resides in the micro / consumer businesses, particularly micro. Rakyat has built up a massive infrastructure that reaches thousands of small villages in what is still a rural country. It lends to people with little credit history, education, earnings, or collateral. The bank’s employees have personal relationships with the villagers, which aids in both business generation and debt collection. In fact, because there are many repeat borrowers, Rakyat has a “proprietary credit history”. If you don’t repay the loan, you get blacklisted. If you do repay all installments on time, you get to borrow more next time around. Furthermore, it’s expensive to generate and service small loans, and a certain critical scale is needed in each village to justify having a branch there. To give you an idea, each rural branch might have 1-3 account officers, who basically spend all day in the field visiting villagers. These account officers are the backbone of the system. Rakyat has that scale today and it will take a long time for others to catch up.
| 2012 | Segment information | ||
| Micro | Retail | Corporation | |
| Net Interest | 16,245 | 14,583 | 3,156 |
| Other Income | 2,882 | 4,034 | 418 |
| Total Rev | 19,127 | 18,617 | 3,574 |
| Operating Expense | 6,812 | 8,090 | 1,872 |
| Credit Provisions | 1,841 | 749 | (36) |
| EBIT | 10,474 | 9,778 | 1,738 |
| Segment Loans | 107,284 | 142,293 | 84,065 |
| Segment Deposits | 126,593 | 225,985 | 82,518 |
| Spread on Loans | 15.1% | 10.2% | 3.8% |
| Credit Costs / Loans | 1.7% | 0.5% | 0.0% |
As you can see, the micro segment by itself is very, very profitable. Significantly, not only are spreads high, but the business generates excess deposits that are invested elsewhere.
Tailwinds
Rakyat in a lot of ways is a play on Indonesian macro. I can say with some certainty that banking system assets will continue to grow at a pretty good clip (call it 15%+), which will be positive for banking profits.
Specifically for Rakyat, the biggest near-medium term opportunity is to increase fee based revenues. Rakyat is probably the worst performer among large Indonesian banks on this metric. Recurring fees are only 8-9% of revs, and most of that comes from account and loan administration charges. Opportunity here includes the adoption of credit/debit cards, internet/mobile/SMS banking, ATM fees, and in the long run asset management / insurance. Fees have been going up and I think will create a few points of low risk, high margin revenue growth.
Headwinds / Risks
First and most obviously, there is Indonesian macro. I don’t have too much insight here. However, one obvious risk is that fuel subsidies continue to chew up 25% of the government budget, or 3+% of GDP. This is the same thing that caused the panic in 2005.
For Rakyat specifically, I think the biggest risk is increased competition. Rakyat is dominant in rural microlending, but several banks, most notably Bank Mandiri wants to enter this very profitable business. Mandiri originates larger loans than Rakyat and NPLs are 5-6%, but they are also growing that business about 70% per year. Today, Mandiri’s micro loan book is less than 1/5 the size of Rakyat, but that could change if these growth rates hold up. The other notable competitor is Bank Danamon. Danamon suffered some bad NPLs are few years ago and retrenched, and finally started growing significantly again in 2012. But they do not seem to be nearly as aggressive as Mandiri. Several additional banks, such as Bank Negara Indonesia(the 4th largest bank), also voiced plans to get into small/micro lending aggressively. Government policy explicitly encourages small/micro lending by all banks.
In general, NIMs in the banking sector have compressed steadily in the past ten years. The reasons are complicated, but it’s probably a combination of (1) Bank Indonesia interest policies/inflation (2) competition (3) banks finding economies of scale, which are being partly passed through to borrowers via smaller spreads. I expect NIMs to continue compressing across the banking system.
Going forward, I think it’s inevitable that more competition will enter the small / micro arena. Demand for loans is growing, and average loan sizes are getting bigger. Borrowers are becoming better educated, and financial sophistication is improving. This will make it easier for other banks to develop a presence. On the bright side, this also means that the overall amount of business available to banks will grow too.
Another long term risk is that Indonesia is urbanizing. So the absolute rural population will probably only be flattish… and absolute rural GDP growth will lag the country.
Lastly, I should mention that we are probably at the trough of the credit cycle in Indonesian banking. System NPLs are at their lowest point since the Asian Fin Crisis, and a lot of the recent earnings improvement is due to reserve releases. My guess is that Rakyat’s 40% ROEs are not sustainable. I suspect the next 5 years will see a number around 25-30%.
Culture
Rakyat is 56.75% owned by the government and most of the workers seem unionized. The management is technically appointed by the government, though the Central Bank can override objectionable candidates – so kind of like a large Chinese SOE. The senior managers make peanuts – not much more than USD$100,000. From what I can see, these guys seem professional and competent, but don’t expect the Steve Jobs of banking to suddenly emerge.
FWIW, the bank seems to be innovative – with initiatives like Teras BRI (special units for tradesmen at wet markets), getting into internet/mobile banking early, sending van-based banking units to remote places, etc. That said, it doesn’t seem to be super different vs. other large Indo banks.
Perhaps the most interesting thing here is the profit sharing / bonus structure that affects all employees. The system itself is rather complicated – based on individual performance, branch/unit performance, and overall bank performance. NPL performance is especially stressed (if NPLs are over a certain level = no bonus... in fact, if NPLs are over a certain level, that employee isn't allowed to underwrite new loans at all). This is a very significant part of pay. The top performers can make more than 6x their base salary, and the average yearly bonus is something like 4 months of salary. These structures were first introduced in the 1980s, and have been expanded greatly since. To me, this is one of the most attractive parts of the story and reflects an alignment of incentives between us shareholders and the employees/management.
Valuation
As mentioned previously, Rakyat trades for maybe 2.9x book. This seems high -- but realize that the ROEs are so high that PE is really quite reasonable. But more importantly, growth prospects are pretty good -- driven by GDP and the formalization of the economy coupled with expanded access to credit. Incremental ROEs should be pretty good -- 20% or more.
How much would you pay for a firm that can invest a very large percentage of internally generated capital at that kind of incremental return? I'd say quite a bit. The recent sell off in Indonesia is giving you that opportunity today.
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