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Edited Transcript of BMRI.JK earnings conference call or presentation 17-Oct-18 10:00am GMT

Q3 2018 Bank Mandiri (Persero) Tbk PT Earnings Call

Jakarta Oct 26, 2018 (Thomson StreetEvents) -- Edited Transcript of Bank Mandiri (Persero) Tbk PT earnings conference call or presentation Wednesday, October 17, 2018 at 10:00:00am GMT

TEXT version of Transcript

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Corporate Participants

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* Ahmad Siddik Badruddin

PT Bank Mandiri (Persero) Tbk - Director of Risk Management & Director

* Donsuwan Simatupang

PT Bank Mandiri (Persero) Tbk - Director of Retail Banking & Director

* Kartika Wirjoatmodjo

PT Bank Mandiri (Persero) Tbk - President Director

* Panji Irawan

PT Bank Mandiri (Persero) Tbk - Finance Director & Director

* Rico Usthavia Frans

PT Bank Mandiri (Persero) Tbk - Director of Digital Banking & Technology and Director

* Sulaiman Arif Arianto

PT Bank Mandiri (Persero) Tbk - Deputy President Director

* Yohan Y. Setio

PT Bank Mandiri (Persero) Tbk - Group Head of IR

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Conference Call Participants

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* Harsh Wardhan Modi

JP Morgan Chase & Co, Research Division - Co-Head, Asia Financials

* Joshua Tanja

UBS Investment Bank, Research Division - MD, Head of Indonesia Research, Head of Indonesia Equity, and Bank Analyst

* Jovent Giovanny

CIMB Research - Analyst

* Mulya Chandra

Morgan Stanley, Research Division - Equity Analyst

* Salman Ali

Citigroup Inc, Research Division - Head of Research for Indonesia and Director

* Wei Yi Kuang

Goldman Sachs Group Inc., Research Division - Executive Director

* Wu Zhuang Chua

Nomura Securities Co. Ltd., Research Division - Associate

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Presentation

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Operator [1]

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Ladies and gentlemen, thank you for standing by, and welcome to Bank Mandiri Third Quarter 2018 Earnings Conference Call. (Operator Instructions) I must advise you that this conference is being recorded today, Wednesday, 17th of October 2018.

And I'd like to hand the conference over to your speaker host today, Mr. Yohan Setio. Thank you, sir. Please go ahead.

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Yohan Y. Setio, PT Bank Mandiri (Persero) Tbk - Group Head of IR [2]

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Thank you all for joining us. We would like to begin the meeting now. I would like to mention a few points before we get started.

First, for those of you joining us on either the webcast or conference call, I would strongly encourage you to download a copy of our presentation materials currently available either from the Investor Relations homepage of Bank Mandiri website or from within the webcast itself.

Second, in the interest of those analysts and investors joining our conference call or webcast, I would like to ask all of you in the room to please speak clearly into a microphone when asking or answering questions.

I would now like to introduce Pak Sulaiman, our Deputy, President Director to begin the meeting. Please, Pak.

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Sulaiman Arif Arianto, PT Bank Mandiri (Persero) Tbk - Deputy President Director [3]

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Thank you, Yohan. I would like to thank all of you for joining us today for discussing our third quarter 2018 financial results and the bank's recent operation performance.

Bank Mandiri continues to show progress in becoming the region's most dominant bank. We are working diligently and our transformation to achieve our vision as Indonesian's most admired and progressive financial institution.

Over the last year, our management team has been focusing on strengthening the risk management practices and making sure that the business growth is aligned with our overall new portfolio strategy.

I would like to spend the opening session on this presentation by discussing macroeconomic situation and our corporate plan before we move into the third quarter result discussion.

Overall, Indonesia macroeconomic situation is still challenging despite not as volatile as other emerging markets, thanks to good coordination between policy markers -- policymakers especially Ministry of Finance and General Bank.

And the third quarter current account deficit is more than 3% of GDP. We believe there might be another round of policy like in the third quarter this year.

The government recently initiated to delay selective infra spending and the implementation of bio-diesel will likely to deliver optimum impact next year, reducing our current account deficit 2.4% of GDP in 2019. However, as the global interest rates are still trending higher next year, our chief economist expects for 75 basis point benchmark rate hike next year following the trend [of rate hike].

As a result of higher benchmark return and U.S. China trade war impact, GDP growth 2018 and 2019 will be [processed] around 5.1% and inflation will be trending higher on 2019 due to currency depreciation and retail and fuel price adjustment.

One of the biggest thing in Indonesia, we keep being prudent and carefully position our portfolio to navigate through these macro challenges. We want to be Indonesia's best ASEAN prominent bank. In order to achieve this, we will solidify our position as the first -- as #1 corporate bank in Indonesia.

We keep leveraging our relationship with our corporate clients to capture business opportunity along the value chain. We identify that the customer in macro segments are our key growth drivers.

On the customer side, we will focus on mortgages and automotive. Our microloans will go through a focus on low-risk salary-based loans. We will employ Bank@Work products that diversify our strength in wholesale to expand our retail distribution.

To achieve our 2020 target, the management team has been focusing on strengthening the fundamentals in the part of -- in the past 2 years, mainly on risk management and IT capability.

For more detail, Pak Siddik will explain about the risk management information followed by Pak Tito for IT transformation.

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Ahmad Siddik Badruddin, PT Bank Mandiri (Persero) Tbk - Director of Risk Management & Director [4]

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Thank you, Pak Sulaiman. We've been doing transformation of the fundamentals of risk management practices from front-end to back-end with the focus on our middle corporate business segment.

Some of the actions we've implemented to enable sustainable and predictable credit performance at middle corporates are as follows: first, we revamped the organizational structure, leadership team and oversight structure by centralizing the management of the big accounts to the head office and direct oversight of our regional teams. We also significantly reduced the credit authority limits of the regional teams. We sharpened the portfolio management strategy and early warning tools.

We actually implemented a very strict discipline in target marketing and pipeline selection processes, and we also did a lot of transformation. We are currently implementing a number of actions at the end-to-end credit processes.

We've also enhanced and implemented a strict forward-looking portfolio and industry sector mix and concentration limit management processes across the bank, leveraging insights from our economists, industry experts and securities analysts at Mandiri Sekuritas.

This risk management transformations needs strong enablers, which are competent people, good governance process and advanced information technology.

Now I'd like to turn it over to Pak Tiko, please.

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Kartika Wirjoatmodjo, PT Bank Mandiri (Persero) Tbk - President Director [5]

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Thank you, Pak Siddik. As we understand, IT and digitalizations are the key factors to determine our success. In the past 2 years, we have been doing major IT transformations that will change the way we serve our customers. These transformations will always continue in order for us to stay updated with the state-of-the-art technology.

As the first step of the IT transformation we focus on revamping our IT security and reliability to drive operational efficiency in the long run. At the back-end, we upgraded our server capacity and fine-tuning performance for our core banking system. At the front-end, we continually enhance our Mandiri Online and Mandiri cash management stability as our platform for our customers for retail as well as wholesale.

To enhance our surface to a different level, we have strategic initiative to change the bank. This includes developing digital value propositions, Bank@Work, data analytics, customer relationship management system.

We are in the process of implementing business process reengineering across our retail portfolio, such as credit scoring system upgrade, workflow speed improvement and decision engine accuracy.

Not to forget that the foundation of our IT transformations, we highlight the importance of building our people, process and governance. We now have a specialist recruitment program for IT and digital banking in addition to our traditional generalist recruitment program, or ODP.

To improve the IT governance, we are now rebalancing the composition within the in-house versus the vendor management in which we gradually bring in-house -- bring in in-house some of the critical IT processes.

As part of our digital transformation, we focus on reliability to drive operational efficiency in the long run. At the front-end, we continuously enhance Mandiri's online stability as our platform for our customer interface.

Since it's launching in 2017, Mandiri Online has been very well accepted by all depositors as shown by the number of active users that grew exponentially reaching 1.6 million active users with average of IDR 27 trillion value -- transaction value per month in September this year.

We still see ample growth and room for continued growth in terms of the number of active users as we have close to 20 million deposit customers in total.

We keep improving features and reliability of Mandiri Online where the users could easily view their deposits and loan data, paying bills to more than 1,000 institutions and even to do a money top-up, our flagship prepaid card.

Our e-Money also shown significant progress with main use case to pay for toll road and parking. Right now, there are 16 million cards outstanding with 1.1 million transactions per month in September 2018.

This bring us to control almost 80% of market share in prepaid card segment in Indonesia. This is a good indicator that customers are actively using our e-Money to do their day-to-day transaction and activities.

We are committed to maintain our leadership in digital banking space in Indonesia to deliver the most value to our clients. I'd like now to turn the presentation over to Pak Panji, Director of Finance, to discuss our financials in greater detail. Pak Panji, please.

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Panji Irawan, PT Bank Mandiri (Persero) Tbk - Finance Director & Director [6]

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Thank you, Pak Tiko. As we implement the adjustment to our corporate plan, we expect some changes to the asset and liability mix. By 2020, we expect Consumer and Micro Banking to contribute at least 31% of our portfolio. We will focus on the mass affluent and fixed income earners by utilizing the Bank@Work strategy.

As a result of strong retail growth, wholesale segment, consisting of large and middle corporate, will swing from currently 66% to 60% of total portfolio.

Within wholesale segment, our risk appetite currently is more towards large corporates as they are proven to be more resilient in terms of asset quality. We keep delivering stronger results in 9 months 2018. On year-on-year benefit, our net interest margin slightly declined by 10 basis points to 5.8% as low-risk segment, which is large corporate, posted the strongest loan growth as part of our bank-wide strategy to step into lower rates portfolio.

Compared to our 6-month result, net interest margin actually started to rebound in third quarter as a result of gradual loan repricing and rising bond yield, while our cost of fund increases was still manageable.

Asset quality continued to improve, with NPL ratio down by 74 basis points year-on-year and 12 basis points quarter-on-quarter, thanks to better risk management practices, strategic loan mix and a stable commodity price environment.

Despite of currency depreciation, we have not deteriorated in asset quality. As a result of our portfolio strategy, our ROE continued to improve by 1.4% to 14.1%, and thanks to 7.5% PPOP growth and 10% reduction in loan loss provision, that drove our bottom line by 20% year-on-year.

We expect this trend to continue in the next couple of years. Financially, our consolidated numbers continue to show improvements. Our loan growth in the third quarter continued to be strong at 13.8% year-on-year, driven by large corporate and micro-segment.

We want to highlight that our asset quality continued to improve since 2016 with NPL currently at 3.0% sharply from 3.8% a year ago. Our proportion of low-cost funds have been stable at 64.5% despite a more challenging market liquidity, thanks to our strong deposit franchise that resulted in healthy CASA growth at 8.8% year-on-year.

As we mentioned, our net interest margin slightly declined year-on-year but started to pick up quarter-on-quarter in the third quarter mainly due to rising bond yield and lending rate adjustment.

Our cost efficiency ratio was stable at 44.2% due to strict cost control. However, we feel that in mid-term, we should be able to deliver better efficiency ratio supported by internal process improvement as well as more disciplined cost control at our subsidiaries.

The bank efficiency ratio stood at only 40.6%. Finally, our earning after-tax increased by 20% to IDR 18.1 trillion, primarily due to moderate PPOP growth and lower credit cost.

The bank's consolidated loan grew by almost 14% year-on-year with the strongest growth came from large corporate, micro and subsidiaries. The microloan growth was mostly coming from salary-based multipurpose loan and low-risk product that we believe can get to 70% of microloans by 2020.

On the other hand, as part of our bank-wide strategy, neither Corporate and SME segment were contracting year-on-year from a combination of tightened underwriting standard, improved target market selection and write-off of bad loan.

We want to highlight here that the SME segment continued to deliver rebound momentum from its bottom level in first quarter this year with asset quality kept under control. Our total deposit increased by 9.2% year-on-year, including CASA growth at 8.8%.

We continue to maintain a strong balance sheet there, but there is room for growth. Year-on-year, our loan grew by 13.8%, faster than the growth of our deposit at 9.2%. These translated to a higher loan-to-deposit ratio of 93.5% from 89.9% a year ago.

On nonloan earning asset, we optimized our yield by shifting from lower yielding interbank asset into marketable securities, bond and loans. Over the year, we have experienced solid expansion of rupiah CASA deposit with low-cost funding currently representing 64.5% of total funding.

Our equity stands at IDR 176 trillion, and this remained the highest level of capital in Indonesia. We continue to prudently managing our capital by paying a special dividend, while maintaining strong capital adequacy ratio of 21.4%.

On the right-hand side bank-only chart, the year-on-year growth momentum mainly came from large corporate and micro segment at 28.7% and 27.1%, respectively.

Consumer loan also grew healthily at 12.7% year-on-year. And expecting loan demand pick up in third quarter, we adjust our time deposit rate and of this has resulted in stable loan-to-deposit ratio at 93.5%.

After sharp increase in FX, loan-to-deposit ratio on June, we tried to moderate it in third quarter, bringing it to a level of 97.8% from 106% in previous quarter. Rupiah loan-to-deposit ratio remained stable within our comfortable range at 91.3%.

In third quarter 2018, we disbursed loan of IDR 154.3 trillion bank-only. New loan disbursement were dominated by the large corporate segment at IDR 101 trillion. The consumer and micro segment together disbursed IDR 24.6 trillion or an increase of 39% year-on-year.

The middle corporate and SME segment together disbursed IDR 28.6 trillion, representing an increase of 11% year-on-year. This marked the second consecutive increase after end of last year. Note that the new disbursement in the middle corporate and SME segment are closely being monitored and targeted to the value chain of our corporate clients, a target market that we perceive has lower risk profile.

Despite our flat interest revenue, we managed to step on funding costs, delivering net interest income growth at 4.2% year-on-year.

Our noninterest income increased by 11.4% year-on-year to IDR 18.8 trillion, mainly supported by Treasury FX business, cash recovery, and a one-off tax issue settlement. With disciplined cost control, 9-month 2018 OpEx growth was quite manageable at 6% year-on-year, resulting in 7.5% PPOP growth.

As we guided, provisioning expense continued to improve, decreasing by 10% year-on-year translating to credit cost just below 2% in the 9 month of 2018 as compared to 2.3% a year ago.

Moderate PPOP growth combined with lower credit cost post our net income to IDR 18.1 trillion, an increase of 20% year-on-year. Our total noninterest income grew by 11.4% year-on-year to IDR 18.8 trillion in the third quarter of 2018.

Main contributors to fee income growth came from 3 sources: number one is subsidiaries income especially from Mandiri Sekuritas; the second is cash recoveries that grew by 22% year-on-year; and the third is coming from treasury FX business that grew 21% year-on-year.

Admin fees declined by 3.7% year-on-year from subcomponent of loan admin fee as we try to optimize our loan growth. The other subcomponent of admin fee, which is deposit admin fee was still growing as we kept increasing the number of low-cost deposit customer.

Despite of SOE banks' ATM consolidation and national payment gateway implementation on debit cards, our transfer and rate transaction fees managed to grow by 2% year-on-year due to strong growth in fee income from Mandiri Online, our digital banking platform.

In total, our fee income represented 30.5% of our total operating income. Our cumulative cost-to-income ratio in 9 months of 2018 was 44.2% consolidated and 40.6% bank only, 70 basis point improvement year-on-year.

We have been able to control G&A expense such as occupancy-related expenses of our physical network, which was flat year-on-year as our expense strategies relies more on digital banking initiatives.

On quarterly basis, third quarter cost-to-income ratio increased by 4.3 percent point due to low base effect in second quarter from a one-off fee income related to tax litigation settlement.

Overall, total OpEx in the 9 months grew by 6.3% year-on-year with the highest growth came from our subsidiaries. We continue to maintain a strong capital ratio at 21.4% as of September 2018. Our CAR is well-above Bank Indonesia minimum for our risk profile at 9% to 10%-plus additional Basel III requirement.

Our common equity Tier 1 and Tier 1 CAR on a bank-only basis stand at 20.24%. The bank's consolidated ROE continued to rebound due to lower cost of credit, moderate PPOP growth and higher dividend payout.

Our third quarter reported bank-only net interest margins stood at 5.5% from 5.4% in previous quarter as asset yield increase was more than enough to offset cost of an increase. Our asset yield remained elevated in third quarter, thanks to higher bond yield and stable loan yield as we gradually reprice our loan portfolio.

Reacting to Central Bank rate increase, we increased our time deposit rates by, on average, 50 basis points. Thanks to our CASA -- thanks to our high CASA ratio, the net impact to cost upfront was manageable at only 20 basis point in the third quarter.

Our focus on retail payment pillar of growth is helping drive our retail deposit base to grow by 8.5% year-on-year as shown in the left-hand side chart.

On the right-hand graph, our rupiah saving deposit and rupiah demand deposit average yield is 1.1% and 2.1% across the portfolio, relatively flat year-on-year.

As we anticipated, rupiah time deposit rate at 5.5% in third quarter 2018 increased by 50 basis points quarter-on-quarter, a level that is well below the increase in the benchmark rate.

Benchmark rate, if I'm not mistaken, is rising by 125 basis points. Our foreign exchange time deposit rate increased to 1.6% due to strong U.S. dollar loan demand amidst thinner dollar liquidity in the market. Our large corporate loan book continued to grow supported by oil and gas, palm oil and electricity.

These 3 sectors together contributed 40% of the large corporate loan book expense and up IDR 62 trillion in the past 1 year. On the other hand, our middle corporate portfolio booked a net contraction of IDR 16 trillion year-on-year with the biggest contraction coming from trade distribution, raw material manufacturing and chemical manufacturing.

Next, I would like to update you on the progress of our wholesale transaction banking initiatives. This is 1 of the 3 main pillars of our strategy. The number of transactions through our cash management services continues to grow rapidly.

We rolled out our cash management platform in 2010 and as of September 2018, we have more than 24,000 users, representing 18% year-on-year increase. The bank completed 115 million cash management transactions in the first 9 months of 2018, an increase of 37% year-on-year.

This is a good indicator that more consumers -- that more customers are actively using our cash management to do their day-to-day transactions. We continue to focus on deepening the relationship with our customers, enhancing the capabilities of our cash management infrastructure, both in terms of reliability of processing as well as customizing it together to focused sectors.

I would like now to turn the presentation over to Pak Donsuwan, Director of Retail Banking to discuss our micro and retail business in greater detail. Pak Donsuwan, please.

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Donsuwan Simatupang, PT Bank Mandiri (Persero) Tbk - Director of Retail Banking & Director [7]

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Thank you, Pak Panji. Consistent with our strategy to grow in retail book faster, the total retail portfolio comprised of small micro and consumer loans now accounts for 34.7% of the bank's loan portfolio.

The biggest driver for retail banking growth came from microloans, increased by 27% year-on-year, mostly coming from fixed income channels. The second-highest growth is auto loan, growing by almost 13% year-on-year.

SME loans contracted by 6.8% year-on-year as we have been focusing on asset quality, of being more selective in targeting customer segment to existing CASA customer and fellow chain of corporate clients.

Note there, however, we already have seen the bottom of our SME loan in the first quarter this year. And since then, the outstanding loan gradually recovered. Our Micro Banking grew by 27% year-on-year and represented 14.2% of total bank-only loan.

We actively pursue growth in salary-based loan growing by 38% year-on-year, representing 63% of the total micro loan.

We believe through better collaboration with wholesale banking and government and institution group, we could grow the salary-based loan to 70% of total micro loan by 2020.

We also helped the government to channel subsidized micro loan that grew by 41% year-on-year. As a result of our assessment of the risk return characteristics of our products, the productive micro loan was contracting by 12% year-on-year.

We are still finding the best way to prudently grow this particular product. Our consumer loans grew by 12.7% year-on-year. Mortgage loan increased by 9.1% year-on-year with payroll customer and first homebuyer as our primary target market.

In credit cards, we have seen the growth starting to improve as we realign our strategy and implemented business process reengineering rising by 9.5% year-on-year.

Through Mandiri Tunas Finance and Mandiri Utama Finance, we are able to grow our vehicle loan significantly. Total auto finance book in Mandiri is now IDR 31 trillion growing at 24% year-on-year.

So next I would like to turn the presentation back to Pak Tiko.

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Kartika Wirjoatmodjo, PT Bank Mandiri (Persero) Tbk - President Director [8]

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Thank you, Pak Donsuwan. Mandiri is adapting to approaches to our digital transformation journey, digitizing our internal processes and customer experience.

As previously mentioned, we are in the process of doing business process reengineering to reduce human interactions and automate the process especially in retail loan. We leverage our actions safe customer database by developing deep data analytics to increase effectiveness and efficiency of our marketing campaign as well as loan application processing.

While digitizing internal process, we also simultaneously enhanced our customer experience. We are in the process of developing system for client onboarding, acquisitions and servicing via Mandiri Online. As an example, our customers in the future will be able to apply online for credit card, personal loan and deposit account opening.

Our regional transactions continue to show strong growth annually reflecting our customer preference to use our banks for their transactional business. Last year, we strengthened our retail transaction banking capabilities by launching our new app, Mandiri Online, which is an improvement to our Mandiri mobile applications.

As of now, we have Mandiri activations of 1.6 million. The users of our mobile internet banking continued to grow and currently, we have 7.9 million mobile banking subscribers and 2.4 million Internet banking users.

The transaction value conducted by -- via our mobile banking platform also shows strong growth at 55% year-on-year, much higher than the growth in ATM, which stand at 7% year-on-year.

E-channels and their ability to drive fee income are an important growth opportunity that we continue to address and factor in. In September, fee income generated from our e-channel business reached 2.4 trillion and this, despite of national payment gateway, ATM consolidations, e-channel fee income still grew by 0.5% year-on-year due to strong usage of our digital platform, mainly our Mandiri Online.

The number of EDC grew from 47,000 in 2010 to 240,000 as of now. The growth in the number of EDC is beginning to normalize as we are focusing on improving the utilization rate of our EDC network.

The enhanced electronic channel networks -- electronic channel products, particularly EDC, are helping us to grow our business, banking account balance, which are IDR 130 trillion, up nearly 3.4% year-on-year.

I'd like now to turn the presentation to Pak Siddik, our Director of Risk Management, to discuss our asset quality.

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Ahmad Siddik Badruddin, PT Bank Mandiri (Persero) Tbk - Director of Risk Management & Director [9]

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Thank you, Pak Tiko. Overall, our assets quality continue to improve as we guided at the beginning of this year. Our consolidated gross NPL ratio improved to 3% from 3.1% in the prior quarter, and 3.7% last year.

Despite the lower credit cost, we still maintain a stable NPL coverage at about 137%. Bank-only, our provision coverage remains strong at 144%. Our category to loan stayed below 5% of total loan and we expect to remain below 5% for the rest of the year.

The bank-only NPL at the end of September 2018 stood at IDR 20.8 trillion, implying a bank-only NPL ratio of 3.0%. Upgrades to performing loans totaled IDR 500 billion. Write-offs accounted for 2.7 trillion during the quarter.

Downgrades to NPL were 3.1 trillion, out of which 70% came from middle corporate and SME segments. Almost all of the NPL from Asia in wholesale segment are already expected, so there was no major surprise downgrades so far.

The second quarter -- or third quarter write-offs were primarily from the middle corporate and SME segment, which represented 66% of the total write-offs. In the third quarter, net NPL downgrades were 0.37% of the total loan, the primary driver was 0.9% downgrade in both middle corporate and SME portfolios.

We'd like to highlight that the improvement in NPL formation has happened for 3 consecutive quarters and came across all segments altogether. Our structured loan book ratio has been stable quarter-on-quarter at 7.4%. Of the total loan with the loan collectibility profile gradually shifting to category 1.

Even though more and more structured loans has been performing, it will take some time for the total restructured loan book balance to show a meaningful decline as the regulator has been conservative in requiring banks not to remove restructuring flag even if the account has been current or the business has been back to normal and we have to actually retain the restructuring flag until the loan is fully repaid.

On the right-hand side of the slide is the recidivism ratio, that is an indicator of our restructured book quality. We've been able to maintain this ratio at low level since last year.

I'd like now to turn over the presentation back to our CFO, Pak Panji, to discuss our subsidiaries and the 2018 guidance. Pak Panji?

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Panji Irawan, PT Bank Mandiri (Persero) Tbk - Finance Director & Director [10]

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Thank you, Pak Siddik. Ladies and gentlemen, Bank Syariah Mandiri continues to be the dominant bank in the Syariah segment. In the third quarter 2018, total financing of Bank Syariah Mandiri increased to IDR 65.2 trillion or grew by 11% year-on-year.

We are starting to see positive result from our transformation of Bank Syariah Mandiri with the nonperforming financing ratio declining to 3.7% from 4.7% a year ago.

Mandiri Sekuritas supports our corporate clients with investment banking and capital market services, Mandiri Sekuritas underwriting volume tripled year-on-year, while trading volume grew by 34% year-on-year.

Mandiri Sekuritas is among the largest equity trading firm by volume in Indonesia with a 5% market share. AXA Mandiri financial services has developed a wide range of bancassurance products across our customer segments. AXA Mandiri has been the most ROE accretive subsidiary with 47 annualized ROE in third quarter 2018.

Bank Mantap or Mandiri Taspen is part of Bank Mandiri's plan to develop pension lending segment. Bank Mantap has been growing its loan book by 56% year-on-year with 0.6% NPL, delivering net income growth of 136% year-on-year.

Even though it's relatively short history, Bank Mantap already showed a 22.4% annualized ROE in the 9 months of 2018. Mandiri Tunas Finance has emerged to be a significant player in auto financing with total outstanding loans of IDR 42.1 trillion, growing by 21% year-on-year with 21% annualized return on equity.

To conclude our presentation, I would like to review our guidance. Number one, our loan growth at 13.8% year-on-year was at the upper end of our full year guidance. We maintain target at 11% to 13% as economic environment is still challenging, especially with interest rate trending higher and currency depreciation.

Our net interest margin at 5.76% was also at the upper end of our full year guidance. We maintained the guidance as time deposits and loan repricing dynamic are still ongoing in fourth quarter.

The efficiency ratio stood at 44.2% within our guidance or below 45% level. The NPL ratio was 3%, and we expect to maintain it within our guidance of 2.8% up to 3.2%.

Cost of credit in the 9 months of 2018 was just below 2.2% at the lower end of our guidance. We maintain the guidance up to 2.2% as we are still gauging the impact of currency depreciation and earthquake in various locations in Indonesia recently.

I would now like to turn the presentation back to Yohan to coordinate the question-and-answer session.

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Yohan Y. Setio, PT Bank Mandiri (Persero) Tbk - Group Head of IR [11]

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Thank you, Pak Panji. We are going to first queue the question on the dial in and then the operator will hand the call back to me. And we will take 3 questions from the room before we take questions from the dial in.

Operator, could you please queue questions from the dial in and hand the call back to me please.

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Questions and Answers

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Operator [1]

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(Operator Instructions)

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Yohan Y. Setio, PT Bank Mandiri (Persero) Tbk - Group Head of IR [2]

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Thank you, operator. Are there any questions from the room? Yes, please, Mulya, Salman and Jovent.

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Mulya Chandra, Morgan Stanley, Research Division - Equity Analyst [3]

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Mulya from Morgan Stanley. My question is on the impact of the recent rising rate, especially on the asset quality. So just want to get a sense, given what already happened, the 150 bps, what will be sort of a rough estimate for cost of credit next year?

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Yohan Y. Setio, PT Bank Mandiri (Persero) Tbk - Group Head of IR [4]

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Now next question from Salman.

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Salman Ali, Citigroup Inc, Research Division - Head of Research for Indonesia and Director [5]

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Actually, I have 3 questions. First is regarding your NIM. If I look at your 9 months NIM and I compare it with your full year guidance, it implies that your fourth quarter NIM is around 4.7% to 5.5% range, which is rather huge. So what is a realistic guidance for the fourth quarter NIM? My second question relates to asset quality and NPL downgrades. If I compare last year with this year, your downgrades are actually higher this year. In 9 months last year, you had downgrades of about IDR 11 trillion. This year, in 9 months, you have downgrades of about IDR 11.3 trillion. And in fourth quarter last year, you had downgrades of about IDR 4.5 trillion. So what is the full year realistic number for your gross downgrades? And my final question is more strategic, that you mentioned that by 2020, you want your corporate loan book to be 40% of your portfolio instead of 45%. If I do the numbers, that means that your corporate loan book will only be growing by about 5% to 7%. Now considering that you are -- you have the second largest third-party limit and the bank with the largest third-party limit is also, say, deemphasizing corporate loan. So the question is that who will then give corporate loans considering that there are very few banks in Book 4?

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Jovent Giovanny, CIMB Research - Analyst [6]

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I am Jovent Giovanny with CIMB. I have 2 questions. My first question is your write-off target NPL. You guided before was IDR 11 trillion to IDR 12 trillion in the 9 months. First half is IDR 9 trillion, so it's already IDR 12 trillion. Do you have any revision on the write-off target? Secondly, on the commercial loan book, on the middle corporate loan book, do you -- how much do you see -- because the first half you told us that the portfolio is -- that's actually at risk was around IDR 30 trillion, if I'm not mistaken. Do you see the numbers actually coming off or actually remains the same, especially for the middle corporate?

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Ahmad Siddik Badruddin, PT Bank Mandiri (Persero) Tbk - Director of Risk Management & Director [7]

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Okay. Let me try to address some of the credit-related questions first, if it's okay. First I think from Mulya, in terms of the impact of the rising interest rates on the asset quality. So we've done basically quite a thorough review in the past 2 months on our potential repricing strategy on our loan books. And then we actually look at which one are our fixed rates, which one are the variable rates and whether the variable rates are tied to LIBOR, et cetera, or whether there is any room for us to make adjustments. Based on those, then we actually identify pockets of segments within our loan books under corporate, middle corporate, SME, including the consumer on the planned increase of the interest rate between now and the first quarter of next year. Some of these increases have been actually initiated in the month of September and October -- September and early October. And then we'll continue to actually gradually reprice certain portion of the books, which we think will not have material impact to the asset quality performance in 2019. So that includes both rupiah loan book as well as foreign currency loan book. And we've made also sensitivity analysis or stress test in terms of the potential -- the cost-benefit analysis of increasing or getting a higher net interest income versus a potential additional provision that we have to take down the road. So basically we'll be very cautious in terms of our decisioning in which segments of the book that we want to actually reprice. We do not want to sacrifice long-term, I guess, benefit versus our short-term revenue targets.

Second, I think on the -- Salman asked question about downgrades prediction, right? Projections. Okay. So I think for the whole bank, until September, we actually have downgraded around IDR 13.5 trillion. And then until end of the year, conservatively, each month we'll probably be downgrading in total about IDR 1.1 trillion to IDR 1.3 trillion between October, November and December. So we'll just need to add IDR 13.6 trillion plus IDR 1.2 trillion per month until end of the year. And this was again driven by higher, probably, downgrades in middle corporate. In our 2018 budget, we originally had a plan to downgrade about IDR 6.5 trillion in middle corporate. We'll probably ending up -- end up with IDR 7.4 trillion in downgrades in middle corporate. The rest of the book are either, we're on target or better. So the -- I guess, the miss is still on the middle corporate, but I think we'll try to do our best to actually do acceleration of any downgrades, if we need to, to this year, because we have some room to actually downgrade for the rest of the year. So we'll probably have a much better start for next year. And then Salman's questions on the strategic plan, increasing the mix of the retail book versus the corporate book. So I think the answer is that we would have to grow both in corporate and the retail books. We will -- we do not have any plan to actually slow down the growth in the corporate book. So I think first 9 months of the year, we probably have grown between 12% to 15% our corporate book. We'll probably grow at a similar rate next year. Of course every deal will have to go pass through minimal standard of assessment. There are a number of pipeline in the corporate loan book, which we are evaluating for next year. And then that means also then accelerating growth in the retail segment. And as already mentioned earlier, we'll continue to grow aggressively in the KSM segment, which is the government, military payroll segments, which is low risk. And then we'll also grow -- continue to grow aggressively in our auto finance business through MTF and MUF. We're also growing a lot more aggressively in the mortgages segment. We think there are rooms for improvement in the whole mortgage industry, especially after the relaxation of the LTV rule by the Central Bank and OJK. And we'll continue to target more of the middle-class mortgages' real estate, residential real estate, which is more mainly first-time homebuyers. We'll also go in selectively into secondary market for salaried segment. Our credit card will probably grow around 10%. And then we'll also grow more aggressively in the SME segment next year. The quality of the new vintages in SME segment this year has been extremely good. Our vintages in the last 2 years NPL is close to 0. And we focus a lot more in the 3 primary segment in SME, which are the existing savings account in SME, where we already have the debit and credit transaction history. Second segment are value chains coming from our corporate clients and the third -- and the BUMNs, SOE clients. And the third one is the cooperative segments of the SOE companies. So these are 3 primary segment we've been growing. There are still lot of opportunities. We'll be growing also selectively into certain new segments next year on a pilot basis. We are actually fine-tuning, revamping our underwriting models and tools in the SME segment. We'll also -- we'll be asking for a higher allocation of the KUR amount, I think, this year. Originally, we were given a target or allocation of IDR 13 trillion of KUR, and we've actually gotten additional IDR 3 trillion -- IDR 3 trillion or IDR 4 trillion, INR 3 trillion. So I think for -- in 2018, we're probably disbursing around IDR 16 trillion here -- Pak Pan, yes? -- of KUR, all good quality. NPL is below 1%, and we still can claim on the insurance on the 70% portion of the principal balance. And we are also going to grow back again in KUM, the micro productive loans that are not KUR, in 2019. So these are the elements of the retail book, Salman. But we'll -- I agree with you we need to come up with a lot more stronger proposition across asset classes in the retail books to be able to realize the 40% mix in retail book, while we want to continue to grow aggressively in the corporate book.

And then I think Jovent asked for the write-off target for this year. So as of September year-to-date, we've written off the whole bank wide IDR 10.8 trillion. And for the rest of the year, probably in total in 3 months, we probably IDR 1.5 trillion again of additional write-off. So around IDR 500 million each for the rest of the year. And then in terms of loan at risk, loan at risk for the middle corporate book. So middle corporate, currently, our loan at risk as of September in middle corporate is around IDR 40 trillion. That consists of collectability 2 of IDR 16 trillion, NPL IDR 15.4 trillion and then collectability 1 restructure is about IDR 8.5 trillion. We're looking at end of the year of loan at risk as around IDR 43 trillion based on the pipeline that we want to do restructuring for the rest of the year. So the increase would come from the coll 1 restructure from around IDR 8.5 trillion to around -- balance would be around IDR 11.2 trillion by end of the year. So that's probably from the -- I think the rest of the other question is on the net interest margin, Pak Panji?

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Panji Irawan, PT Bank Mandiri (Persero) Tbk - Finance Director & Director [8]

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Yes. So regarding the net interest margin actually, we are really -- and we -- we're still prudently managing the asset liability. And like I mentioned before, the counter rate we adjust already, but it's really under staging. And we also not really tempted to join with the rate competition on the special rate of time deposit. That's why we could still maintaining the cost of fund. And then the other thing is 1st of October, we start to transmitting the cost of funding, which is, like I mentioned before, that it's rising already. And we selectively transmitted it to the debitor -- I mean, to the borrower. So 1st of October, it will have an impact on our interest revenue. And then on the other hand also, we have the subsidiary that's still growing and then the yield is also fairly attractive. So we are really utilizing the -- all of the engine that we have. So it is very important for us to get the frontloading on the interest revenue, which is why we're still maintaining the guidance still at the 5.5% to 5.7% because we are having such an uncertainty regarding the interest rate potential hike, potential increasing. So -- but we still stick to the guidance, 5.5% to 5.7%, but we do not want to miss the chances in utilizing the opportunity in adjusting what is the increase of the interest rate and transmitting it to the loan, to the borrower, while we are really careful in adjusting our time deposit as well as all of the funding cost. So that might be my additional point regarding to the NIM. But still we are still -- stick to the guidance.

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Ahmad Siddik Badruddin, PT Bank Mandiri (Persero) Tbk - Director of Risk Management & Director [9]

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We'll optimize the asset yield by doing selective repricing, while on the cost of fund, we also want to be very prudent in terms of giving special rates for the rest of the year, which we actually have proven during the quarter.

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Yohan Y. Setio, PT Bank Mandiri (Persero) Tbk - Group Head of IR [10]

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Thank you. Operator, next we want to take question from the dial in, please.

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Operator [11]

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(Operator Instructions) Your first question comes from the line of Melissa Kuang from Goldman Sachs.

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Wei Yi Kuang, Goldman Sachs Group Inc., Research Division - Executive Director [12]

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I have just 2 questions. Just firstly, in terms of your loan repricing, you mentioned that you have selectively repriced. Can you tell us a few sectors which you haven't had done that and there could be some concerns of asset quality should you actually push through the rate hike? Then secondly, maybe perhaps on your deposits. You have mentioned that you are not joining the competition on the special rate deposits. But just wanted to understand your move on just only slowly repricing the deposits up while Central Bank is trying to raise rates aggressively to try to help the currency on the FX. Just wanted to understand the thoughts about the disconnect there.

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Ahmad Siddik Badruddin, PT Bank Mandiri (Persero) Tbk - Director of Risk Management & Director [13]

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Okay. I think on the question on which of the asset class segment we've been very careful in terms of not increasing the rate due to the impact on the asset quality, obviously, one big segment that we've been very careful is on the middle corporate. These are segment which we are trying to actually fix in terms of the credit quality and sustainability going forward. So any repricing, which we want to do in this segment, we actually do sensitivity analysis and stress test analysis at the account level to see which accounts actually -- can actually bear a higher interest rate going forward without creating or making the account becoming nonperforming in the future. And second also on the highly competitive products such as mortgages and payroll loans. So these are again the segments that we really have to watch very carefully in terms of potential refinance or attrition on our good customer base, so that we'll have to do a cost-benefit in terms of, if we increase the rate, how much of it will actually stay with us and -- versus going to competitors because of these kind -- the products are kind of commoditized where actually there is keen refinance activities from the competitors. So we really watch our good-performing segments in mortgages, in personal loans to make sure that it don't [try]. The rest of the segment, whether it's corporate loans, SME, et cetera, we actually look at potential repricing. Credit card business, obviously, we don't reprice because we are already at the max of the usury rate cap of 2.25% per month. And the other one, in terms of the deposit side, I think about 60%, 65% we are a low-cost deposit, which is savings account. So we actually watch to make sure that the stability or the mix of the low-cost deposit remain at around 65%, 67% and the rest would be supplemented by time deposit. And then we also continue to increase the floats or the funding coming from the transaction banking segment, which Pak Rico has actually explained earlier the fact that the number of users, whether it is the corporate cash managements or Mandiri Online banking, has continued to increase quarter and quarter. These are additional sources of funding to actually manage our liquidity or funding need from time to time. But this is very tactical. We actually have quite often ALCO meetings these days to actually strategize on what we need to do on the pricing, especially on the deposit side. Pak Panji, is there anything you want to add, please.

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Panji Irawan, PT Bank Mandiri (Persero) Tbk - Finance Director & Director [14]

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Actually Pak Siddik already been answering quite completely, but I would like to add some more of that. We are not so aggressive on adjusting the term deposit rate because we have a very strong current account and saving account growth. And we also have another source of funding like the wholesale funding come to the money market, come to do some -- certain repo with the interbank and then bilateral borrowing. So those 3 kind of sources also adding our ability to choose which one is really fitting in to maintain our low cost of funding. And then the other thing is, also we have the variable rate of government bonds, Indonesian government bonds, that's due. So it is a kind of new cash coming and it is adding our -- a bunch of liquidity. On the other hand also, we do some shifting from the interbank placement, which is yielding us a very low yield. So we shift that to the loan. So those kind of things is resulting the 5.76% of NIM.

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Yohan Y. Setio, PT Bank Mandiri (Persero) Tbk - Group Head of IR [15]

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We have 3 more people in the dial-in queuing for question. Operator, if you could please compile all of the question, and then after that, we will answer, please.

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Operator [16]

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Your next question comes from Marcus Chua from Nomura.

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Wu Zhuang Chua, Nomura Securities Co. Ltd., Research Division - Associate [17]

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So I have 3 questions. The first is on asset quality. The restructuring in -- restructure performing in SML seems to be relatively stable across the last 3 quarters. Is there room for upgrades into normal loan? Second question is with regard to cost. I think Pak Rico was talking about IT, getting more into digital. But looking at the cost, that is only growing 3.4% year-on-year. And that bulk of this -- of cost is actually growing in, like, training. I'm not too sure what is the go then. How is that expenditure going to go in for IT. And the last question is on CET1 actually increased to 19.5% -- 19.6% from last quarter's 18.5%. Do you all see more room for higher dividend payout going forward?

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Operator [18]

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Next question comes from the line of Anurag Rajat from JPMorgan.

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Harsh Wardhan Modi, JP Morgan Chase & Co, Research Division - Co-Head, Asia Financials [19]

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This is Harsh Modi from JPMorgan. Two questions. First is, as we head IDR 16,000 on rupiah by year-end, how does your (inaudible) outlook change? And the second, how much really your ability to receive the higher rate change? And second is what's the maximum MDR that you are in plan to go to?

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Operator [20]

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Last question comes from the line of Joshua Tanja from UBS.

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Joshua Tanja, UBS Investment Bank, Research Division - MD, Head of Indonesia Research, Head of Indonesia Equity, and Bank Analyst [21]

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Three questions from me. Number one, what is the impact of the IFRS 9 in January 2020 for Bank Mandiri as of now? Secondly, the deposit growth increases during the third quarter from 5% to 9%. Is it the intention of the bank to reduce the LDR and grow deposit growth further in the fourth quarter? And lastly, on Slide 16, just want to know the driver of the other noninterest income IDR 491 billion that come significantly lower compared to the second quarter of IDR 1891 billion.

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Ahmad Siddik Badruddin, PT Bank Mandiri (Persero) Tbk - Director of Risk Management & Director [22]

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Okay. I'll try to answer some of the credit-related questions first. On the upgrades question from Nomura, let me try to see what's our projection for the rest of the year. So I think total bank year-to-date, we've upgraded around IDR 2.7 trillion of loans. And then additionally, we expect to upgrade around IDR 1.5 trillion to IDR 1.7 trillion for the total bank. Second, I think on the question from JPMorgan that if FX rate becoming around IDR 16,000, what would be the impact to our asset quality? So we've done again sensitivity and stress test analysis. I think one thing which we probably would like to communicate to you that the majority of our loans that are exposed to foreign currency either have 100% natural hedging, they borrow in dollar, their revenues are also in dollar. If they borrow in dollar or then their products are in local currency, there is a big portion of the hedging that has been done above the minimum regulatory requirement. And then also, we also did analysis for situation where the companies have to import the raw materials, while they're selling in rupiah. So we actually analyzed how much of their current margins on their product can actually absorb the increasing exposure to the FX on the raw material import before they are being forced either to increase the product prices, pass on the risk to the consumers or if they can't pass it on, what would be the impact to the cash flow. So we've done a whole lot of analysis and at IDR 16,000, the impact to the asset quality on this exposure, loan exposed to foreign currency, risk is actually very manageable and not significant. The impact on the -- sorry, on the target, I think LDR target will continue to maintain at the current level. We don't see -- about 92%, 93% for the rest of the year. We don't see any significant change to that, taking into account the planned disbursement or increasing exposure in the loan book for the rest of the year versus our ability to increase to get new deposits. On IFRS 9, I think the impact -- as of now we work with actual consultants who actually estimate the impact. I think the impact to IFRS 9 in January 2020, there would be a reduction to our capital about -- around 50 basis points. So that's a onetime impact of 50 basis points based on the analysis, which we've done actually a couple of times with the consultant. So I'll probably turn over to Pak Panji on the -- Pak Rico and Pak Panji on the IT budget, which actually only about 3%, 4% increase, whether there will be additional spending and then questions on the training budget, actually what are we doing about it, I think, and the question on deposits, again, yes. Pak Rico?

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Panji Irawan, PT Bank Mandiri (Persero) Tbk - Finance Director & Director [23]

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Yes, regarding the Common Equity Tier 1 and then 1% high, so we think that we will be adjusting our dividend payout ratio for the next year almost the same treatment with the -- with this year. So 30% for the core and then some more 15%, so that we maintain our return on equity. And then the other things regarding the loan-to-deposit ratio maximum, I think Pak Siddik answered it already. And then actually, basically, we have the term deposit engine that at this time being still we are really carefully utilize and fairly selective in using this. As long as there is loans coming and then it is really giving us a very good margin and then it is positive period, then we might be entering to this term deposit, so that those loan-to-deposit ratio will be adjusted. Actually, what's really happened now is because we are not really jump into the term deposit, we still maintaining and then we still growing the CASA. But once we jump into the term deposit, then actually, the loan-to-deposit ratio will be very much manageable at the level of 92%. So -- but what's the room actually? 94% to 96% is really a kind of area that we could end up to. And then also regarding the IFRS 9 impact on the January 2020, Pak Siddik already been answering, but to be honest, it will have an impact around 1% to 2% to our capital adequacy ratio, which at the moment is 21%. So the impact will be tapering our level of CAR to around 19%. So that's the impact on our IFRS 9. And then the other thing is, dividend already, the driver of the -- oh, yes, regarding the other income. Yes, like I mentioned at the beginning, that we have the tax dispute and then we already been make a provision around 80% and the total amount is IDR 1.4 trillion. And then we lose it on the, what you call it, Supreme Court. So now we have to add somewhere around IDR 300 billion. So it is also have an impact on the others income. So like I mentioned on July, that we win for the 1.08, but we lose on the 1.4% tax. It is selected as scripless SAM, which is happening on the 2013 and then it has happened when we have the, what you call it, the priorities, so we reduced our (inaudible) to be 40%, but -- to the public. But this 40%, there is requirements coming from the tax office. They said, it should be scripless, and it is set by 21st of November, so that nobody -- I mean, no banks that has the, what you call it, paper share, then they got the -- they cannot be -- provide this kind of requirements. So that's a clear thing again of tax dispute. And then it's 5 years already and then the Supreme Court decided on the 31st of July, and we lose it. So -- because we made only 80% of provision, so we have 20%. So this is -- have an impact on our other income -- I mean, on the previous income. That's it.

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Rico Usthavia Frans, PT Bank Mandiri (Persero) Tbk - Director of Digital Banking & Technology and Director [24]

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Let me address the questions on IT. Basically, last year, 2017, our CapEx budget is around IDR 1.5 trillion, and our realization was IDR 1.3 trillion. And this year, we have IDR 1.64 trillion, and our estimation is we will realize around IDR 1.57 trillion. So this is roughly giving you a backdrop of where we are in terms of the IT capital expenditures. And just a couple of months ago, we have discussed on our board, and we have earmarked some numbers, around IDR 2 trillion, for the next 3 years for our retail digital banking roadmap. So this is a quite significant commitment and undertaking on our side that we are taking the digital banking, especially on the retail side, very seriously. On the IT side, what we have been doing so far is that we have recently, what you call, revamped our core banking, and currently, we're running at, a bit technical here, P7 processor, but we will run under P9 processor from IBM. This will give us an ample TPS, transaction per seconds, capacity, which currently stands at 3,200 TPS to around 10,000 TPS. This will give us some room for the next 2 to 3 years that our core banking will be able to sustain our growth. On the middleware, we're also introducing new platforms, the API management. If you look into the -- you notice the markets, we also have published the API for e-money top up. You know that we have 80% of e-money market share, and one of the problem is that where to top up your e-money. So we have given, for example, in this case, we have worked with Tokopedia, and we publish our API and we give it to them, so our customers can top up their e-money from Tokopedia app. So this is something that in the future we'll be doing more and more, exposing our services, exposing our network, exposing our customers to third party, to fintech company whereby we'll be able to leverage both sides in terms of the synergy and as well as the building more healthy business model with the cooperation with the fintechs. And other than that, we're also doing 5 to 6 big major projects like what we mentioned earlier, BPR, business process reengineering, whereby we actually, we're automating and redigitizing our underwriting process for retail loans and retail credit cards, so that we'll be able to publish this services again to third-party website or third-party e-commerce. So in -- currently, we are sourcing our retail customer from physical channels. In the futures, as early as next year, we are aiming at the -- improving our capability to source our retail asset customers from virtual channel like e-commerce or third-party application. And to, what you call, to drive those kind of process, we also revamped our analytics capabilities. We have invested a lot in big data infrastructures. We work with Teradata, we work with -- we use Hadoop, a lot of technology behind this analytics in order for us to be able to perfect the brain for our process to make our decisions much faster. So those are some of the initiative on the IT side that we are doing right now.

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Panji Irawan, PT Bank Mandiri (Persero) Tbk - Finance Director & Director [25]

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I would like to add some more explanation regarding the training cost. So the training cost growing by 49%. It is, number one, because of the subsidiary need to do some planning program for preparing all of the employees to have the capabilities in executing all of the KPI. And then, by fourth quarter, we really expecting that the growth will be around 11% to 12% for the training cost. And yes, it is regarding the frontloading because we need to complete all of the training by the third quarter.

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Yohan Y. Setio, PT Bank Mandiri (Persero) Tbk - Group Head of IR [26]

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Okay. Thank you to Board of Director, and thank you for all participants for joining this earnings call. If you have any further questions, feel free to email or call us. Thank you.

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Operator [27]

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Ladies and gentlemen, that does conclude our conference for today. Thank you for participating. You may all disconnect.