BCA's initial public offering: Let the buyer beware
By Melville S. Brown
The following is the second of two articles on the Indonesian banking crisis.
JAKARTA (JP): Public confidence in the nation's banking system continues to be fragile as news of improved performance in one bank is quickly overtaken by the revelation of yet another loan scandal in another.
The following is a brief refutation on some of the more noticeable mis-interpretations and false conclusions found in the Danareksa report:
The reduction in the percentage of non-performing loans (NPLs) is a natural consequence of the write off and transfers of over Rp 63 trillion of bad debts and insider loans to the Indonesian Bank Restructuring Agency (IBRA).
This is a reflection of the misuse and mismanagement of the bank in the past and should not be interpreted as a positive step which now sets the bank up with a "strong capital base" to support rapid growth or emphasized as a marketing tool for the sale of bank shares.
Comparing Bank Central Asia's (BCA) core deposit base and cost of funds favorably against its competitors is not a meaningful exercise. More important is the internal impact of the size, demographics and cost of the bank's deposit base on its own operational efficiencies and profitability.
The only real value in having a well established funding base and millions of depositors is predicated on the potential to profitably utilize the funds raised.
While there is no doubt that BCA's current deposit customer base of approximately eight million accounts, 80-90 percent of which are reported to be individuals, provides the bank with a strong cushion for funding; account profitability is however, another matter.
The ability to generate significant fee income from deposit customers very much depends on who those depositors are and what type of banking transactions they conduct.
In the case of BCA, it is highly unlikely that they will be able to achieve the anticipated growth levels in fees and commissions (projected to grow at an average annual rate of 32.4 percent over the next three years) given the high volume of individual depositors with low average balances in savings accounts.
Contrary to the analyst's conclusions, the majority of BCA's deposits are not in the lower rate Tahapan savings accounts but in the more costly time deposits.
As of the end of 1999, some 15 percent of the bank's deposits were in demand deposits, 36 percent in savings accounts, and 49 percent in time deposits. Of the time deposit base, some 93 percent are in one-month deposits, which carried an average interest rate of 24.6 percent during 1999.
Currently BCA is offering 10.5 percent for one-month time deposits in rupiah and 10 percent for the Tahapan savings accounts; not a significant difference in any case. These rates are equal or slightly higher than the bank's major competitors and not 150-200 basis points below as presented in the report.
As interest rates were significantly higher at the beginning of the year and almost 5 months of the year have now past, it is safe to assume that the average cost of funds for the institution will still come in well above the projected 9 percent level for the entire 2000 financial period.
According to the financial reports, BCA's average costs of funds decreased significantly from 44.3 percent for 1998 to 20 percent for 1999. This decrease is due primarily to Bank Indonesia monetary policies and the regulations that deposit interest rates cannot exceed the government SBI rates by more than 100 basis points lest the bank face losing its deposit insurance coverage.
Despite this sharp reduction in interest expense, BCA still suffered a negative net interest margin (NIM) of almost 6 percent for the year.
To project a further reduction in interest rates when they are already negative in real terms and to input a historically unprecedented average cost of funds of only 9 percent (a further decrease of 55 percent) for the next three years; is totally unrealistic.
The concept that BCA has been recapitalized and truly has a capital adequate ratio (CAR) of 43 percent is patently wrong. This "recapitalization" did not entail any fresh equity and is basically an accounting maneuver whereby non-performing loans were replaced with government debt in the form of long-term, low- yielding, and illiquid bonds.
The recapitalization exercise did not provide any new funds to the bank and it is therefore wrong to state that the bank's "strong capital base" reduces the need to raise cash in the future . It is a virtual certainty that BCA will need new capital infusions in the near future.
Since this initial public offering will not provide any fresh capital to the bank, it highly problematical that it can generate the type of internal growth that has been projected.
The CAR has actually lost most of its meaning in Indonesia due to the volume and structure of these bonds which now support virtually the entire banking sector. Basing BCA valuation calculations on this false capital base can only lead to false conclusions and a misrepresentation of the bank's investment rating.
The bank does not have a "huge potential" to grow its loan book based on these false CAR and LDR (Loan to Deposit Ratio) calculations. The entire deposit base is not available to fund new credit as most of it has already been "disbursed" and is now supporting the government bonds that have replaced the bank's poor loan portfolio.
The bank's growth potential is in fact limited to its excess liquidity consisting of approximately Rp 12 trillion in interbank placements and Rp 3 trillion in Bank Indonesia treasury notes (SBIs).
The bank's past history of concentrating its lending activities primarily to related parties and large Salim group companies is well documented.
The analyst's arguments that the bank is now well positioned to compete effectively in the retail banking market and expand with a new wave of consumer based lending seem to be based primarily on wishful thinking and the believe that because the "new" management is operating under a performance based agreement with IBRA, a strategic turnaround is bound to occur.
Since most of the new management team are "graduates" from the Indonesian state-owned banking system, there is understandable concern that they are not the most qualified bankers to lead BCA's shift into retail banking and its financial recovery.
BCA will now have to compete in this new market with the likes of BNI, Bank Mandiri, Bank Danamon, all of which have extensive branch networks as well, and the foreign banks, led by Citibank and American Express and HSBC.
In properly calculating the share value of BCA, as well as any of the banks participating in the recapitalization program, the recapitalization bonds should be realistically risk-weighted.
As with all the 'recapitalized' banks, BCA's CAR has been liberally calculated by assigning a zero risk weighting to these government bonds, thereby decreasing the denominator and artificially inflating the equity position.
If the bonds are in fact tradable on the secondary market they should be valued or priced on the bank's balance sheet at their true market price, with corresponding downward adjustments to the capital base if they sell at a discount.
Since last February, the banks have been allowed to sell up to 10 percent of this bond portfolio-there have been virtually no trades. The average bid price for these bonds in the secondary market has been at a 20 to 30 percent discount from par which recognizes the fact that the yield on these instruments is unrealistically low for the risk they represent.
Of course a sale of these bonds at their true market value would result in a further "decapitalization" of the banks and a significant embarrassment to both bank Indonesia and the International Monetary Fund (IMF).
It should be recognized that the Danareksa calculations for determining the "fair value" of BCA shares are fundamentally flawed by the expedient assumption that the bank's reported equity base of Rp 6.2 trillion is considered to be real money and that the bonds are worth their par value.
The various calculations that the Danareksa analysts have performed to arrive at an estimated fair value for BCA shares are an interesting exercise in imagination and fiction.
To achieve an adjusted book value per share (BVPS) of Rp 1,206 the analysts have again assumed that the "core capital" of the bank is real, that the bank actually earns a profit in the year 2000, and that other banks (but not BCA) are somehow over- provisioned for their NPLs.
The most obviously over optimistic aspect of the projections appears in the decrease and relatively flat growth rate in interest income (despite the projected 60 percent growth in new loans) coupled with an incredible reduction in interest expenses -- while simultaneously projecting significant growth in the funding base.
Meanwhile interest expenses are expected to decrease by an unrealistic 52 percent this year before creeping back up by 7.3 percent in 2001 and 2002. Concurrently, the average annual growth in deposits is projected to be 8 percent over the next three years.
Lastly, there are a number of misstatements regarding the value of the bank's branch network, automatic teller machine system and importance to the "national payment system" of the country.
The analyst's have totally discounted the true volatility factor in the bank's deposit base. Indonesian depositors are indeed rate sensitive and the customer loyalty to BCA is not as strong as advertised, as evidenced by the massive runs in 1998.
In the midst of a fractured financial system, BCA stands out as a "large" bank. However, among the remaining commercial banks in the system, BCA is no better than its competitors. Its touted branch network system will be hard pressed to maintain market share against either Bank Mandiri or the re-emerging Bank Danamon, which will soon add to its network through its absorption of 8 smaller commercial banks.
The central question regarding the sale of shares in BCA remains: What's in it for the investor? Foreign and local investors alike are primarily concerned about return on their investment and safety of their principal.
If one believes in the future stability of the Indonesian government, then they can assume that their principal will be recoverable. However, there is very little reason to believe that an investment in BCA shares will provide any real return for the foreseeable future.
For the investor BCA's near term performance on the Jakarta Stock Exchange appears to be problematical at best. There has been minimal movement in financial shares over the past two years and it is highly unlikely that any investor will realize a positive gain through the sale of shares for several years.
Nor will investors enjoy any dividend income until at least the year 2003, and only them if the bank exceeds its projected performance targets.
For foreign investment fund managers the issue is further complicated by the question as to why they would risk a part of their fund portfolio in what is essentially a government-owned illiquid mutual fund operating in a moribund financial sector?
The market reaction to this share offer has ranged from lukewarm to outright rejection. Investor concerns regarding Indonesia's ongoing political and economic instability continue to impede new investment into the local markets.
It appears that IBRA has some level of commitment for foreign participation in only 20 percent of these shares (approximately 132 million shares) from foreign investors.
To set an opening "fair value" for BCA shares at Rp 1,400 -- the analyst's calculated the pricing to be between Rp 1,600 and Rp 2,650 per share using their reverse titration accounting methods-- when the average trading price for all publicly banks in the local market is a mere Rp 257, is simply beyond credibility to all but the most inane.
Most banks, which still qualify for listing on the Jakarta exchange, are trading at very low multiples (often less than 1X) with share price ranging from Rp 125 to Rp 400/share. IBRA's pricing is over 5 times the cost of the average bank stock currently available on the Jakarta exchange and represents a 17.5X multiple against 1999 earnings and a 4.4X multiple against projected earnings for 2000.
There does not appear to be any real individual investor support in the local market and in order to lay-off 22.5 percent of these shares it appears that the government will resort to the pressure tactics of the prior administration, i.e. to force feed these shares into various government companies and pension funds.
It will be most interesting, if such data is ever disclosed; to see exactly how much of this offer is "purchased" by such institutions as Taspen, the Garuda pension fund, other state- owned banks, and the state-run social security funds Jamsostek.
The writer is an international banker and financial markets analyst. He has worked in Indonesia for over 10 years as a bank representative, advisor to Bapepam, financial advisor with IBRA and an independent consultant to the financial sector.