Investors in the dark on Indonesian bank ownership

This problem comes more than one month after domestic regulators proposed reducing the legal limit a foreign entity can hold in a domestic bank to 50% - or less - from the current 99%. State banks and branches of foreign banks will likely be exempted from the rule, central bank Governor Darmin Nasution told media, but it will be retroactive and affect existing foreign stakeholders.

Sovereign wealth funds Temasek Holdings and Khazanah Nasional and global buyout firm TPG have an interest in the sector, as do several international financial institutions.

Details of the plan are still in the works, but a cap is expected to be announced before the end of the year.

Despite the uncertainty, no foreign investors have started preparing to exit. "Foreign owners are monitoring developments closely, but we've seen new regulations proposed before and sometimes they're implemented and sometimes not," says David East, head of transactions and restructuring at KPMG-PT Siddharta Consulting in Jakarta. "The industry appears to be sitting tight until something definitive is proposed."

Who's affected?

Indonesia opened its arms - and its domestic banks - to foreigners to help rebuild its financial system after the Asian financial crisis. Private equity funds, overseas banks and institutions sprung to take advantage of the situation.

According to the US State Department, as of March 2011, Indonesia housed 122 commercial banks, of which 10 are majority foreign-owned and 28 are foreign joint venture banks. Each of the country's top 10 banks is owned either by the government or by foreign parties, with the exception of BCA, which is held by one of the country's richest families. These 10 institutions account for nearly 65% of banking sector assets.

The scope for financial services expansion in Indonesia is enormous. The World Bank estimates that less than half of the country's citizens have money in a bank - with 40% "financially excluded" from credit - and only 17% borrowed from banks as of November 2010. However, household incomes are rising, driven by GDP growth that rebounded in 2010 to 6.1% and is tipped to reach 6.2-6.5% this year, according to State Department calculations. About 60% of GDP derives from domestic consumption. In these conditions, bank lending is expanding at a rate of 20% a year.

Indonesian regulators recognize the sector's potential and want to keep the profits within the country. Sources tell AVCJ that similar rumblings about banking ownership caps emerged before the global financial crisis, but discussions were put on hold due to the finance industry's uncertainty. Furthermore, Indonesia's lenders have struggled to win approval to open branches elsewhere in the region - notably in Singapore and Malaysia - and this jars policymakers given Jakarta's relatively liberal approach.

Should the cap be implemented retroactively, Temasek would have to sell down much of its 67.4% stake in Bank Danamon, Indonesia's sixth-largest lender. TPG would have to do the same with its 59.7% interest in BTPN, as would Khazanah with its 93% indirect stake in Lippo Bank, the country's ninth largest lender by assets.

Malaysia's largest banks would find themselves in a bigger bind. CIMB owns nearly 97% of Bank CIMB Niaga while Maybank has 95% of Bank International Indonesia (BII). CIMB claimed that over 27% of its profit in the first quarter of 2011 was derived from its Indonesian business. Maybank claimed 4% from BII.

According to UBS Investment Research, CIMB is targeting 60% of its overseas earnings to be derived from Indonesia by 2015, while Maybank hopes BII will account for 10-15% of its earnings by that time.

Singaporean banks are less reliant on the Indonesian market, with UOB tracing 5.4% of its 2010 pre-tax income to the country compared to 2% apiece for OCBC and DBS.

"This is definitely a negative," Bernard Ching, researcher at Malaysian investment banking group ECM Libra, tells AVCJ. "Right now no one is in any position to make plans because they don't know which direction this is going to go. Of course banks like CIMB and Maybank are still arguing that the rules should not be applied retroactively, and are lobbying that Indonesian banks owned by individuals and families - which is a lot of them - aren't able to recapitalize these banks if things go wrong."

Waiting game

Discussion on bank caps has been ongoing, but it is possible that regulators won't enact a law in the near future. KPMG's East says ongoing regulatory uncertainty remains a key issue for investors in the country: "Investors used to be wary of a wide parcel of country risks, many of which have gone away, except for regulatory risk, legal uncertainty and the judicial system, as well as regional autonomy in some sectors."

At the heart of the uncertainty is the size of the cap itself. Regulators have suggested a 50% limit, but they are thought to be considering something lower, which would obviously impact any divestment plans. There is also no specific timeline as to when the cap might be implemented.

A lingering question is who might buy the bank stakes if foreigners are forced to sell down. Indonesia's banking sector has traditionally been rife with M&A opportunities, with private equity and foreign financial institutions willing to pay a premium for a foothold in the market. But a blanket cap on foreign ownership means the most acquisitive category of buyer is no longer able to take a controlling stake and similarly cannot rely on future expansion through acquisitions.

As a result, local players are the main potential buyers, yet their ability to meet asking prices is in question. There are a number of financial players large enough to buy competitors, but many don't necessarily have the balance sheets to do so.

Furthermore, a number of domestic banks are owned by high net worth families who might be keen to expand, but other lenders doubt these families' ability to participate in a recapitalization should economic conditions sour. "If a bank sells to an individual or a family, I'd classify that as a regression as opposed to a progression," ECM Libra's Ching says.

AVCJ Research reveals two private equity divestments in Indonesian banks in the past six years, and both have been exited to Malaysian entities. In 2005, a group that included Chinatrust Financial Holding, Ferrell Opportunity Capital and Matrix Capital Partners sold a 52% stake in PT Bank Lippo to sovereign wealth fund Khazanah for $352 million. Three years later, Kookmin Bank and Temasek Holdings received $1.3 billion from Maybank for their 56% holding in PT Bank Internasional.
Such transactions may be a thing of the past.

Malaysia's RHB Capital has been chasing an 80% stake in Medan-based lender PT Bank Mestika Dharma, worth RM1.16 billion ($375.5 million), since October 2009. But last month it chose to step back from the deal until the foreign ownership issue is resolved. Malaysia's Affin Holdings has called off its acquisition bid for PT Bank Ina Perdana, citing similar reasons.

Others refuse to jump to conclusions. The consensus remains that there is little cause for concern about exiting stakes because foreigners are still keen to snap up minority positions in banks, as are domestic lenders. That activity alone could bid up prices.

According to one Indonesia-focused GP, the principal implications of the cap concern foreign owners' ability to fully consolidate all the equity and the profits from Indonesian units to their parent companies. While this might be the case on paper, it's unlikely to prevent the foreign owners from maintaining de facto control over local operations even with minority ownership.

"Banking in Indonesia is still highly lucrative, and the new ownership restrictions only moderately dampen the attractiveness of owning banks onshore," the GP says.

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• Topics
• Southeast Asia
• Financials
• Temasek Holdings
• TPG Capital
• KPMG
• Matrix Partners