BCA's initial public offering: Let the buyer beware<\/p>\n
By Melville S. Brown<\/p>\n
The following is the second of two articles on the Indonesian
\nbanking crisis.<\/p>\n
JAKARTA (JP): Public confidence in the nation's banking system
\ncontinues to be fragile as news of improved performance in one
\nbank is quickly overtaken by the revelation of yet another loan
\nscandal in another.<\/p>\n
The following is a brief refutation on some of the more
\nnoticeable mis-interpretations and false conclusions found in the
\nDanareksa report:<\/p>\n
The reduction in the percentage of non-performing loans (NPLs)
\nis a natural consequence of the write off and transfers of over
\nRp 63 trillion of bad debts and insider loans to the Indonesian
\nBank Restructuring Agency (IBRA).<\/p>\n
This is a reflection of the misuse and mismanagement of the
\nbank in the past and should not be interpreted as a positive step
\nwhich now sets the bank up with a "strong capital base" to
\nsupport rapid growth or emphasized as a marketing tool for the
\nsale of bank shares.<\/p>\n
Comparing Bank Central Asia's (BCA) core deposit base and cost
\nof funds favorably against its competitors is not a meaningful
\nexercise. More important is the internal impact of the size,
\ndemographics and cost of the bank's deposit base on its own
\noperational efficiencies and profitability.<\/p>\n
The only real value in having a well established funding base
\nand millions of depositors is predicated on the potential to
\nprofitably utilize the funds raised.<\/p>\n
While there is no doubt that BCA's current deposit customer
\nbase of approximately eight million accounts, 80-90 percent of
\nwhich are reported to be individuals, provides the bank with a
\nstrong cushion for funding; account profitability is however,
\nanother matter.<\/p>\n
The ability to generate significant fee income from deposit
\ncustomers very much depends on who those depositors are and what
\ntype of banking transactions they conduct.<\/p>\n
In the case of BCA, it is highly unlikely that they will be
\nable to achieve the anticipated growth levels in fees and
\ncommissions (projected to grow at an average annual rate of 32.4
\npercent over the next three years) given the high volume of
\nindividual depositors with low average balances in savings
\naccounts.<\/p>\n
Contrary to the analyst's conclusions, the majority of BCA's
\ndeposits are not in the lower rate Tahapan savings accounts but
\nin the more costly time deposits.<\/p>\n
As of the end of 1999, some 15 percent of the bank's deposits
\nwere in demand deposits, 36 percent in savings accounts, and 49
\npercent in time deposits. Of the time deposit base, some 93
\npercent are in one-month deposits, which carried an average
\ninterest rate of 24.6 percent during 1999.<\/p>\n
Currently BCA is offering 10.5 percent for one-month time
\ndeposits in rupiah and 10 percent for the Tahapan savings
\naccounts; not a significant difference in any case. These rates
\nare equal or slightly higher than the bank's major competitors
\nand not 150-200 basis points below as presented in the report.<\/p>\n
As interest rates were significantly higher at the beginning
\nof the year and almost 5 months of the year have now past, it is
\nsafe to assume that the average cost of funds for the institution
\nwill still come in well above the projected 9 percent level for
\nthe entire 2000 financial period.<\/p>\n
According to the financial reports, BCA's average costs of
\nfunds decreased significantly from 44.3 percent for 1998 to 20
\npercent for 1999. This decrease is due primarily to Bank
\nIndonesia monetary policies and the regulations that deposit
\ninterest rates cannot exceed the government SBI rates by more
\nthan 100 basis points lest the bank face losing its deposit
\ninsurance coverage.<\/p>\n
Despite this sharp reduction in interest expense, BCA still
\nsuffered a negative net interest margin (NIM) of almost 6 percent
\nfor the year.<\/p>\n
To project a further reduction in interest rates when they are
\nalready negative in real terms and to input a historically
\nunprecedented average cost of funds of only 9 percent (a further
\ndecrease of 55 percent) for the next three years; is totally
\nunrealistic.<\/p>\n
The concept that BCA has been recapitalized and truly has a
\ncapital adequate ratio (CAR) of 43 percent is patently wrong.
\nThis "recapitalization" did not entail any fresh equity and is
\nbasically an accounting maneuver whereby non-performing loans
\nwere replaced with government debt in the form of long-term, low-
\nyielding, and illiquid bonds.<\/p>\n
The recapitalization exercise did not provide any new funds to
\nthe bank and it is therefore wrong to state that the bank's
\n"strong capital base" reduces the need to raise cash in the
\nfuture . It is a virtual certainty that BCA will need new capital
\ninfusions in the near future.<\/p>\n
Since this initial public offering will not provide any fresh
\ncapital to the bank, it highly problematical that it can generate
\nthe type of internal growth that has been projected.<\/p>\n
The CAR has actually lost most of its meaning in Indonesia due
\nto the volume and structure of these bonds which now support
\nvirtually the entire banking sector. Basing BCA valuation
\ncalculations on this false capital base can only lead to false
\nconclusions and a misrepresentation of the bank's investment
\nrating.<\/p>\n
The bank does not have a "huge potential" to grow its loan
\nbook based on these false CAR and LDR (Loan to Deposit Ratio)
\ncalculations. The entire deposit base is not available to fund
\nnew credit as most of it has already been "disbursed" and is now
\nsupporting the government bonds that have replaced the bank's
\npoor loan portfolio.<\/p>\n
The bank's growth potential is in fact limited to its excess
\nliquidity consisting of approximately Rp 12 trillion in interbank
\nplacements and Rp 3 trillion in Bank Indonesia treasury notes
\n(SBIs).<\/p>\n
The bank's past history of concentrating its lending
\nactivities primarily to related parties and large Salim group
\ncompanies is well documented.<\/p>\n
The analyst's arguments that the bank is now well positioned
\nto compete effectively in the retail banking market and expand
\nwith a new wave of consumer based lending seem to be based
\nprimarily on wishful thinking and the believe that because the
\n"new" management is operating under a performance based agreement
\nwith IBRA, a strategic turnaround is bound to occur.<\/p>\n
Since most of the new management team are "graduates" from the
\nIndonesian state-owned banking system, there is understandable
\nconcern that they are not the most qualified bankers to lead
\nBCA's shift into retail banking and its financial recovery.<\/p>\n
BCA will now have to compete in this new market with the likes
\nof BNI, Bank Mandiri, Bank Danamon, all of which have extensive
\nbranch networks as well, and the foreign banks, led by Citibank
\nand American Express and HSBC.<\/p>\n
In properly calculating the share value of BCA, as well as any
\nof the banks participating in the recapitalization program, the
\nrecapitalization bonds should be realistically risk-weighted.<\/p>\n
As with all the 'recapitalized' banks, BCA's CAR has been
\nliberally calculated by assigning a zero risk weighting to these
\ngovernment bonds, thereby decreasing the denominator and
\nartificially inflating the equity position.<\/p>\n
If the bonds are in fact tradable on the secondary market they
\nshould be valued or priced on the bank's balance sheet at their
\ntrue market price, with corresponding downward adjustments to the
\ncapital base if they sell at a discount.<\/p>\n
Since last February, the banks have been allowed to sell up to
\n10 percent of this bond portfolio-there have been virtually no
\ntrades. The average bid price for these bonds in the secondary
\nmarket has been at a 20 to 30 percent discount from par which
\nrecognizes the fact that the yield on these instruments is
\nunrealistically low for the risk they represent.<\/p>\n
Of course a sale of these bonds at their true market value
\nwould result in a further "decapitalization" of the banks and a
\nsignificant embarrassment to both bank Indonesia and the
\nInternational Monetary Fund (IMF).<\/p>\n
It should be recognized that the Danareksa calculations for
\ndetermining the "fair value" of BCA shares are fundamentally
\nflawed by the expedient assumption that the bank's reported
\nequity base of Rp 6.2 trillion is considered to be real money and
\nthat the bonds are worth their par value.<\/p>\n
The various calculations that the Danareksa analysts have
\nperformed to arrive at an estimated fair value for BCA shares are
\nan interesting exercise in imagination and fiction.<\/p>\n
To achieve an adjusted book value per share (BVPS) of Rp 1,206
\nthe analysts have again assumed that the "core capital" of the
\nbank is real, that the bank actually earns a profit in the year
\n2000, and that other banks (but not BCA) are somehow over-
\nprovisioned for their NPLs.<\/p>\n
The most obviously over optimistic aspect of the projections
\nappears in the decrease and relatively flat growth rate in
\ninterest income (despite the projected 60 percent growth in new
\nloans) coupled with an incredible reduction in interest expenses
\n-- while simultaneously projecting significant growth in the
\nfunding base.<\/p>\n
Meanwhile interest expenses are expected to decrease by an
\nunrealistic 52 percent this year before creeping back up by 7.3
\npercent in 2001 and 2002. Concurrently, the average annual growth
\nin deposits is projected to be 8 percent over the next three
\nyears.<\/p>\n
Lastly, there are a number of misstatements regarding the
\nvalue of the bank's branch network, automatic teller machine
\nsystem and importance to the "national payment system" of the
\ncountry.<\/p>\n
The analyst's have totally discounted the true volatility
\nfactor in the bank's deposit base. Indonesian depositors are
\nindeed rate sensitive and the customer loyalty to BCA is not as
\nstrong as advertised, as evidenced by the massive runs in 1998.<\/p>\n
In the midst of a fractured financial system, BCA stands out
\nas a "large" bank. However, among the remaining commercial banks
\nin the system, BCA is no better than its competitors. Its touted
\nbranch network system will be hard pressed to maintain market
\nshare against either Bank Mandiri or the re-emerging Bank
\nDanamon, which will soon add to its network through its
\nabsorption of 8 smaller commercial banks.<\/p>\n
The central question regarding the sale of shares in BCA
\nremains: What's in it for the investor? Foreign and local
\ninvestors alike are primarily concerned about return on their
\ninvestment and safety of their principal.<\/p>\n
If one believes in the future stability of the Indonesian
\ngovernment, then they can assume that their principal will be
\nrecoverable. However, there is very little reason to believe that
\nan investment in BCA shares will provide any real return for the
\nforeseeable future.<\/p>\n
For the investor BCA's near term performance on the Jakarta
\nStock Exchange appears to be problematical at best. There has
\nbeen minimal movement in financial shares over the past two years
\nand it is highly unlikely that any investor will realize a
\npositive gain through the sale of shares for several years.<\/p>\n
Nor will investors enjoy any dividend income until at least
\nthe year 2003, and only them if the bank exceeds its projected
\nperformance targets.<\/p>\n
For foreign investment fund managers the issue is further
\ncomplicated by the question as to why they would risk a part of
\ntheir fund portfolio in what is essentially a government-owned
\nilliquid mutual fund operating in a moribund financial sector?<\/p>\n
The market reaction to this share offer has ranged from
\nlukewarm to outright rejection. Investor concerns regarding
\nIndonesia's ongoing political and economic instability continue
\nto impede new investment into the local markets.<\/p>\n
It appears that IBRA has some level of commitment for foreign
\nparticipation in only 20 percent of these shares (approximately
\n132 million shares) from foreign investors.<\/p>\n
To set an opening "fair value" for BCA shares at Rp 1,400 --
\nthe analyst's calculated the pricing to be between Rp 1,600 and
\nRp 2,650 per share using their reverse titration accounting
\nmethods-- when the average trading price for all publicly banks
\nin the local market is a mere Rp 257, is simply beyond
\ncredibility to all but the most inane.<\/p>\n
Most banks, which still qualify for listing on the Jakarta
\nexchange, are trading at very low multiples (often less than 1X)
\nwith share price ranging from Rp 125 to Rp 400\/share. IBRA's
\npricing is over 5 times the cost of the average bank stock
\ncurrently available on the Jakarta exchange and represents a
\n17.5X multiple against 1999 earnings and a 4.4X multiple against
\nprojected earnings for 2000.<\/p>\n
There does not appear to be any real individual investor
\nsupport in the local market and in order to lay-off 22.5 percent
\nof these shares it appears that the government will resort to the
\npressure tactics of the prior administration, i.e. to force feed
\nthese shares into various government companies and pension funds.<\/p>\n
It will be most interesting, if such data is ever disclosed;
\nto see exactly how much of this offer is "purchased" by such
\ninstitutions as Taspen, the Garuda pension fund, other state-
\nowned banks, and the state-run social security funds Jamsostek.<\/p>\n
The writer is an international banker and financial markets
\nanalyst. He has worked in Indonesia for over 10 years as a bank
\nrepresentative, advisor to Bapepam, financial advisor with IBRA
\nand an independent consultant to the financial sector.<\/p>",
"url": "https:\/\/jawawa.id\/newsitem\/bcas-initial-public-offering-let-the-buyer-beware-1447893297",
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