Farallon sees no quick fix for bonds

Farallon sees no quick fix for bonds

Leigh Murray, Dow Jones, Jakarta

PT Bank Central Asia's new foreign owner says it will take up to five years to reduce its dependence on bonds which the Indonesian government pumped into the bank to save it from collapse after the 1997 economic crisis.

Farallon Capital - a U.S. investment firm that headed a consortium that bought a 51 percent stake in BCA last month for $540 million - also won't cut any staff at BCA, the nation's largest bank, and doesn't plan any significant changes to the board, its Asia director, Raymond Zage, said in an interview Tuesday.

Analysts consider BCA - the country's largest retail bank - among the strongest in the sector.

But like other banks, BCA remains dependent on government bonds, and not higher-yielding loans, to make money. This is hampering BCA's earnings growth - especially now as interest rates are falling. Huge question marks also hang over how the government - which is running a huge deficit - will be able to afford to roll-over these bonds from next year when they start to come due.

Indonesia issued US$60 billion worth of bonds into its national banking system after the crisis - one of the world's largest financial bailouts - to replace loans that had gone bad.

With many of those loans still non-performing, BCA and other banks remain dependent on bonds. In BCA's case, bonds account for more than half its earning assets.

"It's probably a three to five year process to get the bonds to a level that's more acceptable for a conventional bank," Zage said.

Farallon is considering a plan by the Indonesia Bank Restructuring Agency - the agency which issued the bailout bonds and now manages the bad debt - to swap restructured loans for bonds, Zage said.

This would allow BCA to get back to lending, which should improve its margins. It would also allow the government to reduce its debt. Interest payments on the recapitalization bonds mean this year's deficit will total a huge 2.5 percent of gross domestic product.

Critics point out the plan isn't without risks: many restructured loans could easily turn bad again as Indonesia's economy remains weak. That could push banks back into a weak financial position again.

"Solving that issue is not something that happens overnight," he said.

Another solution is for the government to create a secondary bond market to take over some of the debt.

Progress here has been slow, with plans to issue treasury bills for the first time to create a short-term yield curve yet to get off the ground. The Parliament has delayed the passing of a draft law allowing the government to issue t-bills since the middle of last year.

BCA's share price is among the best-performing in Indonesia, having risen to a high of Rp 3,275 two week's ago, up sharply from Rp 1,475 at the end of 2001.

But the stock has fallen to Rp 2,675 at 0700 GMT (2 p.m. Jakarta time) Tuesday, as analysts suggest the company's earnings might not be that exciting while interest rates are falling.

BCA had Rp 58.21 trillion ($6.2 billion) in government bonds on its books at the end of last year, representing more than half its assets. These bonds have a variable interest rate linked to the one-month Sertifikat Bank Indonesia notes.

The earning power of these bonds is gradually being eroded, with the government guiding SBI rates lower to try and cut the cost of funding its budget deficit. One-month SBI rates peaked at almost 18 percent late last year, but have fallen to 16.61 percent at last week's auction.

Merrill Lynch, a stock brokerage, recently advised clients to take profits on BCA's rally due to the dependence on government bonds. But it advised a buy for the long term as the bank remains Indonesia's dominant retail bank.

BCA has the largest branch network in the country and with 21,000 staff across the country.

Farallon restate the company's policy that it has no plans to cut staff numbers at BCA, which had been feared by the banks workers unions, Zage said.

"There's no change in that strategy," he said.

Overseas investors trying to buy Indonesian assets have been stymied by local politicians and unions opposing sales of local assets to foreigners.

U.K.-based Standard Chartered had to pull out of a bid to buy a controlling stake in PT Bank Bali in 1999 due to local worker opposition to the sale.

Farallon narrowly beat Standard Chartered Bank's consortium to take control of BCA last month.

Farallon has appointed Deutsche Bank AG as technical adviser to run BCA.

The Farallon-led consortium includes Farindo Holdings (Mauritius) Ltd. and Alaerka Investment Ltd., which is owned by shareholders of Indonesia's third largest cigarette maker PT Djarum.