This article first appeared in The Edge Malaysia Weekly, on April 4 - 10, 2016.

CIMB Group Holdings Bhd’s group CEO Tengku Datuk Seri Zafrul Aziz openly admits that he is disappointed the group’s Indonesian operation has taken longer than expected to show improvement.

In a candid interview with The Edge, he says it has been one of the biggest challenges he’s had to deal with since taking the helm of CIMB Group in February last year.

The Indonesian subsidiary, PT Bank CIMB Niaga Tbk, once seen as the most promising of CIMB Group’s overseas ventures, used to account for about a third of the group’s profit.

These days, it has weighed down the group because of high provisions for bad loans, analysts say. CIMB Niaga’s relatively high exposure to the troubled coal sector amid the slowing economic growth in Indonesia saw it having to make massive loan provisions, starting from the final quarter of 2014. This has taken a toll on CIMB Group’s bottom line.

“I was hoping that Indonesia would do better last year than the year before. But as we discovered, there are areas in which we probably should have been more careful in extending those loans, and so we were affected. Indonesia, last year also, we thought would turn around, but it didn’t, so we had to provide more for some of the assets,” Zafrul says.

The bulk, or 71.7%, of the RM2.2 billion loan provisions that CIMB Group made in FY2015 came from Indonesia. The rest were from Thailand (22.7%) and Malaysia (5.6%).

“What was disappointing in a way for us, was the higher-than-expected provisions in Indonesia. We budgeted for it, but we didn’t budget for it this large. So we hope that we learnt from that and this year, we need to make sure we put in place all the right systems and learn from the mistakes [so that] going forward, this doesn’t happen again,” he adds.

Elaborating on the mistakes, he says: “We were over-exposed in the commodity sector and in this case, the coal sector. What we didn’t expect was the economy in Indonesia — we thought it would turn around and stabilise, but it got worse.”

CIMB Niaga’s core net profit (after stripping out one-off items) fell by 59.3% to IDR856 billion in FY2015. The one-off items include IDR471 billion in expenses from a mutual separation scheme as well as IDR100 billion expenses from recalibrating its micro business (80 branches were closed) and merging its auto businesses.

The decline in core earnings was largely due to higher provisions — up 54.7% year on year to IDR5.36 trillion — mainly from the impairment of coal and coal-related loans.

CIMB Niaga accounted for just 8% of CIMB Group’s profit before tax in FY2015.

There are 118 banks in Indonesia, but the Big Four — Bank Mandiri, Bank Central Asia, Bank Rakyat Indonesia and Bank Negara Indonesia — account for about 44% of the industry’s total assets and deposits.

CIMB Niaga is the fifth largest bank there and was one of the most exposed to the coal sector. It had close to 5% of its loans extended to the coal and coal-related sector as at end-2014, whereas the Big Four, on average, had only 2% of their loans linked to that sector, an analyst says. CIMB Niaga’s exposure to the sector has since come down to 4% as at end-2015. 

“Yes, the sector was plagued by the falling coal price, but CIMB Niaga’s problem was also the type of corporates it lent to ... they were more tier-two type corporates. The stronger corporates went to the bigger banks,” another analyst remarks.

Given that the Big Four control about half of the banking sector’s deposit franchise, they are in a better liquidity position, and tend to have the first pick of the more blue-chip customers, the analyst explains.

Zafrul is optimistic that CIMB Niaga, under the leadership of president director Tigor M Siahaan — he replaced Arwin Rasyid in April 2015 after the latter retired in February after serving for more than six years — will do better in FY2016.

“We have to learn [from past mistakes] and make sure they are not repeated, make sure that the process is in place, make sure that our risk and our risk appetite are clear. We’re looking at, for example, choosing the right corporates, moving away from term loans more to working capital ... so that’s been happening,” Zafrul says.

Tigor will have a couple of new additions to the CIMB Niaga management team soon.  “The AGM is coming up ... you will see the new team,” says Zafrul, declining to elaborate further. He points out that the provisions made in Indonesia were for loans from two years ago. “There are no (provisions) for new loans. These are all loans from two years ago, which we had to make certain decisions on, on management as well. And going forward, investors will have to see the changes that we make. So hopefully,  they will be reflected in the [group’s] share price. I think it has, to a certain extent, but there’s still a lot more [to do] and we’ve got to make sure that we have the confidence of the investment community by continuously implementing our plans.”

But CIMB Niaga is not alone in facing tougher times. Most Indonesian lenders saw a deterioration in asset quality in recent quarters as the economy slowed, hurt by thecollapse in commodity prices and weaker rupiah.

Indonesia’s central bank expects economic growth to be “slightly higher” this year compared with 4.8% in 2015, governor Agus Martowardojo was reported as saying on March 23. Last year’s growth was the weakest since the global financial crisis in 2008/09.

Zafrul is optimistic that President Joko Widodo’s ongoing stimulus measures will have a positive impact on the economy. Since September 2015, the government has come out with a series of economic stimulus, which included infrastructure spending and tax incentives, aimed at boosting economic growth and improving the investment climate.

The Indonesian central bank has also cut its key interest rate three times this year, by 25 basis points each time, to 6.75% now, to boost growth.

“We are a bit more optimistic about Indonesia. We are seeing the measures implemented over the years probably coming to fruition this year. So, we are quite confident that our performance in Indonesia will be better this year than last year,” he says.

Provisions at CIMB Niaga will likely stay at elevated levels in the first half of this year, before improving in the second half, according to Zafrul. Asset quality will improve, he says. “I may be a bit cautious but I think the first-half provisions will still be high, but the second half will be better.”

Analysts remain cautious. “CIMB’s Indonesian subsidiary may not see a strong recovery as yet in 2016. While provisions are largely out of the way for that unit, reorganising its business model will be a focus in 2016. Net interest margin may still decline because of this,” says DBS Research in a February 26 report following CIMB Group’s FY2015 results.

Asset quality conditions still appear shaky for the first half of this year, the research house adds. CIMB Niaga’s gross non-performing loan ratio rose to 3.74% in the fourth quarter of FY2015 from 3.17% in the third quarter.

Nevertheless, its gross impaired loan ratio, a more forward-looking indicator of asset quality as it covers impaired loans that could potentially turn non-performing, improved to 5.03% from 5.18%. 

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