Fitch Ratings-Singapore-25 August 2009: Fitch Ratings today noted that profitability at several of its rated large to mid-sized Indonesian banks have remained generally strong in 2008 and H109, and their pre-provision profits should be able to absorb the increase in credit costs as loan quality deteriorates in 2009 and possibly into 2010. The agency also expects the extent of deterioration in NPLs to be moderate with the Indonesian economy expected to post positive albeit weaker GDP growth (3.0% in 2009 and 3.8% in 2010). This underpins the Stable Outlook on the ratings for most Indonesian banks rated by Fitch.

Nevertheless, the management of loan quality will remain a major challenge for banks in Indonesia due to the more volatile operating conditions, poor corporate debt history and the evolving state of the banks' risk management.

Fitch's simulation results of a 'stress scenario' on 10 large to mid-sized Indonesian banks rated by the agency, where operating income is assumed to be under pressure and additional charge-offs assumed on foreign currency loans and other impaired loans, indicate that the combined earnings of the banks can absorb up to around 4% level of credit costs. This is estimated to be equivalent to a new NPL formation rate of about 5% per year. As the agency expects NPLs to rise by up to 2-3 pp to 6%-6.5% in 2009/2010, earnings should be able to absorb the higher credit cost charges with capital impairment risks expected to be low for most banks.

However, the results do vary widely among individual banks, with weaker earnings at some of the mid-sized to smaller banks exposing them to higher capital impairment risk should operating conditions deteriorate significantly. The stronger profitability at some of the large Indonesian banks should also be viewed against the riskier operating conditions in Indonesia, which can cause loan quality to deteriorate rapidly should conditions become more difficult. Corporate loans are still sizeable at around 35%-40% of total loans, while other impaired loans such as special mention loans are still high (and larger than NPLs) at around 7% of total loans at the 10 Indonesian banks. Around 30% of special mention loans are restructured loans which will be prone to a relapse if conditions were to deteriorate significantly. Under the agency's 'stress scenario', additional charges have been assumed for such loans to reflect the higher default risks.

The high capital ratios at these banks have been eroded by the rapid expansion of loan assets in the last five to six years, although they are still considered satisfactory with Tier 1 capital ratio at an estimated 12.9% at end-2008, as compared with 16%-17% at end-2003; Total CAR ratio has been reduced to around 15% from 21%-22% previously. The application of Basel II in 2010 could shave around 2pp from capital ratios based on the charge for operational risk alone (but before any offset from credit savings, if any). Fitch believes that more capital restorative measures will be desirable and may be necessary to support expansion plans and provide a sufficient buffer against the generally riskier conditions in Indonesia.

The report, "Stress Test on Indonesian Banks: Earnings Cushion Fairly Strong, Capital Ratios Reduced But Still Satisfactory; Rating Outlook Stable" will soon be available on the agency's paid website, www.fitchresearch.com.

Contacts: Tan Lai Peng, Singapore +65 6796 7219; Ambreesh Srivastava, +65 6796 7218; Julita Wikana, Jakarta, +6221 52902462; Humprey Tjia, +6221 52902461.

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