BANK SOHAR SAOG (BKSB.MSM)

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1 INVESTMENT RESEARCH COMPANY UPDATE BANK SOHAR SAOG (BKSB.MSM) Growth in loan book and a wider interest spread result in a record net profit in Q Stock still trades cheaper than its peers on Mcap/Net loans RECOMMENDATION : BUY CMP : RO TARGET PRICE : RO VARIANCE : 18% INVESTMENT OPINION FINANCIAL INDICATORS CMP (26 Aug 2009) MCAP (RO MN) 204 EPS TTM (bzs) BV (RO) P/E TTM P/BV 2.06 ROAA (TTM) 0.04% ROAE (TTM) 0.40% LOANS/DEPOSIT RATIO 98.30% TOTAL ASSETS (RO MN) NETWORTH (RO MN) ANALYSTS August 27, 2009 Anil Kumar, CAIA Vice President - Research anilkumar@fincorpinv.org Tel: (+968) Joyce Monteiro Analyst joyce@fincorpinv.org Tel: (+968) Ext.340 Mable Pereira Analyst mable@fincorpinv.org Tel: (+968) Ext.340 Bank Sohar (BKSB) has delivered its best ever performance so far in Q making a net profit of RO 2.45 million. The bank has emerged stronger from the recent economic slowdown with its local market share by loans increasing from 6% at the end of Q to 9% at the end of Q In fact, Bank Sohar has overtaken both Oman International Bank and Oman Arab Bank in terms of loan size and is twice as big as Ahli Bank by the same measure. Its NPL/Gross loans ratio at 0.33% was among the lowest in the industry at the end of June 30, 2009 compared to those of the larger Omani banks which varied between 3.5% and 4.8%. Net Interest Income in Q surged 122% YoY to RO 5.4 million while on a sequential basis it was higher by 28%. This increase can be attributed to a widening of its average interest rate spread from 1.9% in Q to 3.3% in Q and a 61% YoY growth in its net loans and advances to RO 739 million. Average yield on loans increased to 6.9% in H from an average of 6.5% in Cost of funds improved steadily from 4.8% in Q to 3.6% in Q as deposit rates softened except for a sharp jump in Q owing to tight liquidity conditions. The bank has seen a 16% sequential growth (Q2 09 vs. Q1 09) in its total deposits while all the other banks in Oman have reported negative to flat growth in their deposit base during the same period. Fee and commission income which is the largest component of its other operating income also rose from RO 0.77 million in Q to RO 1.76 million in the second quarter. Bank Sohar needs to improve its fee based income stream in the coming years to boost its bottom line. The bank has now attained a critical size in its loan book and as a result its cost to income ratio sharply improved to 55% in Q from an average of 73% in The bank was previously making losses consistently in all the previous quarters except for a small profit in Q However, the bank has turned around in Q erasing its entire loss of RO 2.26 million in FY 2008.

2 BANK SOHAR SAOG We expect Bank Sohar to report an EPS of RO in 2009 and net assets per share of RO on a conservative basis (assuming higher provisions in the next two quarters). The stock currently trades at a relatively high P/BV of 2.06x which is justified in our opinion given the strong growth it had displayed vis à viand Ahli Bank at its peers in recent quarters. In terms of Mcap/Net loans, it is trading much cheaper than its nearer competitors like OIB 0.26x (refer page 6). Applying the mean Mcap/ /Net loans ratio of 0.33 of listed banks to its loan book of RO 739 million, the stock deserves a valuation of RO per share. We therefore recommend a BUY on Bank Sohar with a target price of RO likely to be achieved by the end of this year. BUSINESS MODEL Bank Sohar SAOG (BKSB), a fairly recent entrant into the Omani commercial banking arena, operates within the Sultanate providing various banking services throughh a network of 13 branches. The bank s operations range from retail banking to corporate banking as well as providing treasury services. Established in 2007, BKSB has adopted an aggressive lending strategy capturing a decent 9% (June 30, 2009)market share by loans and a similar share by deposits, despite strong competition. BKSB boasts of a RO 203 million Mcap and a total asset base of RO 973 million as of June 30, The bank s capital adequacy ratio currently stands at 13.09%. BKSB increased its corporate loan book to RO 404 million in Q from RO 166 million at the end of On an average, corporate loans make up for 55% of its total gross loans with the construction sector accounting for 20% of them. Personal loans, on the other hand, grew to RO 346 million in Q from RO 137 million at the end of The bank has been proactive in managing its NPL/gross loan ratio whichh fell from from 0.43% at the end of Q to 0. 33% at the end of Q The bank s deposit base made up of savings, current, term deposits and CDs increased from RO 334 million at the end of 2007 to RO 752 million in Q Figure 1: BKSB corporate loan book (2008) Figure 2: BKSBB deposit base (H1 2009) Construction 20% Govt. 11% Import Trade 10% Other 40% Non Resident 7% Financial Institutions 6% Manuf. 6% Call Deposits 12.8% Current Depositss 7.8% CDs 12.0% Savings Deposits 11.6% Term Deposits 55.8% Despite the global financial crisis and a challenging economic environment, BKSB has managed to report a profit for H Higher yields on corporate loans and lower cost of funds has led to a net interest spread of FINCOR P INVESTMENT RESEA RCH Page 2

3 3.3% for BKSB in Q Further BKSB has a relatively small AFS portfolio of RO 88 million compared to its total assets of RO 973 million. The effects of the recent financial crisis on its balance sheet have been minimal. Q PERFORMANCE BKSB reported a 122% YoY growth in its net interest income in Q to RO 5.4 million led by a sharp increase in interest income. Net interest spread rose to 3.3% in Q compared to 1.9% in Q and 2.3% in Q On a sequential basis, the bank has been able to lower its cost of funds from 4.6% in Q to 3.6% in Q while average yield on loans remained constant at 6.9%. The decline in deposit rates in line with prevailing low interest rates across the world has helped the bank in improving its net interest income. While most banks in Oman have slowed down lending significantly in the aftermath of the economic slowdown, Bank Sohar has relatively been aggressive in the past four quarters as shown in Table 1 below: TABLE 1 : INCREMENTAL LOAN GROWTH Q3 08 Q4 08 Q1 09 Q2 09 AVERAGE BANK SOHAR 21.0% 14.5% 7.3% 8.6% 12.9% BANK MUSCAT 9.2% 7.0% 1.3% 0.9% 4.6% NATIONAL BANK OF OMAN 4.8% 13.8% 0.9% 1.6% 4.5% AHLI BANK 10.1% 8.0% 3.1% 0.5% 3.9% BANK DHOFAR 6.0% 7.5% 5.1% 4.4% 5.8% OMAN INTERNATIONAL BANK 5.7% 5.0% 0.6% 2.0% 3.0% As shown in Table 2 below, Bank Sohar and Ahli Bank have the lowest NPL ratios among banks in Oman. NPL coverage at the end of Q was 475% while capital adequacy ratio has been satisfactory at 13.1%. TABLE 2: NPL/GROSS LOANS Q3 08 Q4 08 Q1 09 Q2 09 AVERAGE BANK SOHAR 0.14% 0.12% 0.43% 0.33% 0.3% BANK MUSCAT 2.01% 8.62% 2.82% 4.76% 4.6% NATIONAL BANK OF OMAN 5.52% 4.38% 4.46% 4.68% 4.8% AHLI BANK NA 0.19% NA NA 0.2% BANK DHOFAR 3.76% 3.40% 3.03% 3.61% 3.5% OMAN INTERNATIONAL BANK 9.28% 8.91% 9.17% 9.11% 9.1% Fee and commission income rose 15% YoY and 128% QoQ to RO 1.76 million which is a significant gain. The sharp decline in the financial markets in the latter half of 2008 and in Q has adversely affected fee based income in the first quarter of this year which dropped to RO 0.77 million from a high of RO2.59 million in Q We forecast around 20% lower fee based income in 2009 compared to that of Net interest income in 2009 is likely to be higher by 104% YoY while a 59% YoY growth in operating income can be expected. FINCORP INVESTMENT RESEARCH Page 3

4 The bank reported an operating profit of RO 3.88 million in H of which RO 3.31 million was obtained in Q Impariment allowance on loans was lower in Q at RO 0.73 million as against RO 1.21 million in Q An impairment loss of RO 0.25 million on its investment portfolio in Q has been written back fully in Q Net profit in Q was RO 2.45 million as against a loss of RO 38K in Q and a loss of RO 776K in Q The bank has reported its best ever bottomline so far in Q attributable to an exceptional growth in net interest income, lower provisions and cost control. Net profit for H was RO 1.67 million which works out to an EPS of 1.67 baisas. Except for a small net profit of RO 325K in Q3 2008, the bank has never been able to generate profits owing to its small loan book and high operating expenses. We believe that with the strong build up in its loan book in the past four quarters, Bank Sohar should be able to generate profits for the rest of the year as higher net interest income would sufficiently meet its operating expenses. We forecast a net profit of RO 5.48 million in 2009 or an EPS of 5.5 baisas. TABLE 3: CONSOLIDATED BALANCE SHEET AT A GLANCE IN (RO 000) H Q NET LOANS AND ADVANCES 739, ,265 INCREMENTAL CHANGE 9% 14% CORPORATE LOANS (GROSS) 404, ,684 PERSONAL LOANS (GROSS) 346, ,417 TOTAL DEPOSITS 751, ,013 LOANS/DEPOSITS RATIO 98% 99% NPL/GROSS LOANS 0.33% 0.12% DUE FROM BANKS/DUE TO BANKS 16% 77% RETAINED EARNINGS (3,079) (4,750) BOOK VALUE PER SHARE (RO) Source: Company financial statements Total assets of the bank have increased by 15% to RO million at the end of H as against RO million at the end of Net loans and advances recorded an increase of 16% to RO million during the same period. Customer deposits have increased by 21% from RO million at the end of 2008 to RO million at the end of H Term deposits from corporate clients account for nearly 63% of its deposit base. The bank has made fresh purchase of investments categorised as available for sale to the tune of approximately RO 60 million in H The bank faces short term liquidity problem with Due from banks and money market placements as a percentage TABLE 4: SHAREHOLDING PATTERN of Due to banks and money market deposits SHAREHOLDER % HOLDING falling precipitously from 268% at the end of Q3 AL GHADEER INVESTMENTS 16.00% 2008 to 16% at the end of Q ROYAL COURT OF AFFAIRS 14.57% Source: Company financial statements Accumulated losses at the end of H were reduced to RO 3.1 million from RO 4.7 million at the end of We expect the bank to completely erase its accumulated losses by the end of Q Book value per share at the end of H stood at 99 baisas which works out to P/BV multiple of 2.06x at its last traded price of RO FINCORP INVESTMENT RESEARCH Page 4

5 STOCK PRICE PERFORMANCE BKSB has clearly outperformed the MSM 30 index with a YTD return of 70% as against 15% from the Index. 10% 0% Figure 3: BKSB Price Movement BKSB MSM 10% 20% 30% 40% 50% 60% 70% Source: MSM VALUATION As shown in Table 5, BKSB appears to be undervalued with a Mcap/Net loans ratio of 0.27 as against its banking peer group average of As discussed in the earlier sections, Bank Sohar has seen the highest incremental growth in loans in the previous four quarters. In terms of loan book, BKSB has exceeded that of OIB, Oman Arab Bank and is twice bigger than that of Ahli Bank at the end of Q Applying the peer group s average Mcap/net loan ratio of 0.33 on its loan book of RO 739 milion, Bank Sohar should have a market capitalisation of RO 242 million which translates to a price of RO per share. We expect Bank Sohar s book value to be RO by the end of 2009 with retained earnings turning positive at RO 0.73 million. Given the high growth rate in its loan book with a very low NPL ratio of 0.33%, the stock can command a higher P/BV of 2.3x. This implies a target price of RO by the end of the year. We therefore give a BUY recommedation on this stock with a target of RO TABLE 5: PEER COMPARISON INDICATORS BKSB BKMB BKDB NBOB ABOB OIBB AVERAGE P/E (TTM) P/BV DIV YIELD NIL 2.46% 2.35% 5.74% 2.44% 8.68% Mcap/Net loans Net Loans & advances (RO mn) 739 3,811 1,118 1, Mcap (RO mn) FINCORP INVESTMENT RESEARCH Page 5

6 BANK SOHAR SAOG COMPARATIVE FINANCIALS Despite the global financial crisis, bank credit in Oman continued to grow in H with the CBO reporting a 24% YoY increase in combined bank credit at RO 9.5 billion at the end of May However, the pace of credit growth has been decelerating since the beginning of this year as banks tightened their lending norms perceiving a higher credit risk. Despite adverse conditions, Bank Sohar has achieved the highest incremental growth in loan book on QoQ basis in the past four quarters at an average of 12.9%. This is sharply higher than its closest competitor Ahli Bank which reported an average loan growth rate of 3.9%.. Among the larger banks, BKDB has seen the highest growth rate in loans at an average rate of 5. 8% for the past four quarters while market leader BKMB s loan book grew at an average rate of 4.6%. Bank Sohar has grown its corporate loan book by a compounded quarterly rate of 14% from RO 214 million at the end of Q to RO 404 million at the end of Q Likewise personal loans grew at 15% compounded on a quarterly basis from RO 174 million to RO 346 million for the same period. Figure 4 : Incremental Loan Growth 25.0% BKSB BKMB NBOB ABOB BKDBB OIBB 20.0% 15.0% 10.0% 5.0% 0.0% 5.0% Q3 08 Q4 08 Q1 09 Q2 09 Bank Sohar s market share by loans among listed banks increased from 6% at then end of Q to 9% at then end of Q ( Figure 5 & 6). Figure 5: Banks' Market share by loans at the end of Q OIBB OAB BKSB 8% 7% 6% BKDBB 13% ABOB 4% NBOBB 17% BKMB 45% Figure 6: Banks' Market share by loans at the end of Q2 09 OIBB OAB BKSB BKDB 8% 6% 9% 13% ABOB 4% NBOB 16% BKMB 44% FINCOR P INVESTMENT RESEA RCH Page 6

7 NPL/gross loans ratio for Bank Sohar is among the lowest in the industry at an average 0.25% in the past four quarters slightly higher than that of Ahli Bank which reported NPL/gross loans ratio of 0.19% at the end of OIB has the highest average NPL/gross loans ratio at 9.1% in the industry while BKMB and BKDB have average ratios of 4.55% and 3.45% respectively (Figure 7). The fact that BKSB has been able to grow its loan book in double digits in a weaker business environment with no significant increase in bad loans is a pointer to its efficient credit risk management. All the NPLs are fully provided with an average NPL coverage ratio of 804% during the past four quarters. Figure 7: NPL/Gross loans 10.00% 9.00% 8.00% 7.00% 6.00% 5.00% 4.00% 3.00% 2.00% 1.00% 0.00% BKSB BKMB NBOB BKDB OIBB Q3 08 Q4 08 Q1 09 Q2 09 Bank Sohar has also achieved the highest incremental growth rate in deposits during the past four quarters at an average of 15.1%. This is significantly higher than 6.5% growth rate achieved by Ahli Bank for the same period. Among the larger banks, BKDB has achieved the highest average incremental growth in deposits at 5.5% while market leader Bank Muscat s deposits grew at an average rate of 3.8%. OIB is the only bank which has reported a decline in deposits at an average rate of 3.2%. BKSB s loans to deposit ratio at the end of Q amounted to 98% compared to Ahli Bank s 114%. The average loans/deposit ratio for the banking sector was 106% at the end of Q and hence there is scope for Bank Sohar to increase its loan book in the coming quarters given its strong 16% growth in deposits in Q Figure 8 : Incremental Deposit Growth 40% 35% 30% 25% 20% 15% 10% 5% 0% 5% 10% 15% BKSB BKMB NBOB ABOB BKDB OIBB Q3 08 Q4 08 Q1 09 Q2 09 FINCORP INVESTMENT RESEARCH Page 7

8 Net interest spread is highest for OIB in its peer group at 5.2% annualised in H while Ahli Bank and Bank Sohar come at the bottom with a spread of 2.7% each. OIB has the lowest cost of funds in the industry at 1.3% on an annualised basis as it has the highest proportion of low cost deposits carrying an interest rate of 0 2% % 120.0% 100.0% 80.0% 60.0% 40.0% 20.0% 0.0% 118.6% Figure 9: Loans/deposits ratio Q % 106.4% BKMB BKDB NBOB OIBB ABOB BKSB Bank Sohar has improved its interest rate spread by 100bps in Q over Q as a result of decline in cost of funds while average lending rate held steady at 6.9%. Cost of funds for banks is unlikely to increase significantly in the coming quarters owing to low inflation and an improved liquidity in the global financial system. Due to increased risk perception, banks are unlikely to lower their lending rates and hence the chances of narrowing of spreads are minimal. Net interest income is therefore likely to be as good as in Q for Bank Sohar in the next two quarters. Bank Sohar has been incurring losses nearly every quarter since its listing in 2007 owing to its highest cost toincome ratio in the industry. However, in Q the bank has managed to bring down its cost to income ratio significantly from 88% in Q to 55% in Q Average cost to income ratio for the bank in the past four quarters was around 69%. We expect the average cost to income ratio to be around 60% in 2009 driven by higher operating income and cost control. Bank Muscat had the lowest cost to income ratio in the industry at 25% in H % Figure 10 : Key Performance Indicators 114.1% 98.3% 20.0% 18.0% 16.0% 14.0% 12.0% 10.0% 8.0% 6.0% 4.0% 2.0% 0.0% Cost to income Ratio (RHS) Net interest spread (LHS) ROE (annualised) (LHS) 80.0% BKMB BKDB NBOB OIBB ABOB BKSB 70.0% 60.0% 50.0% 40.0% 30.0% 20.0% 10.0% 0.0% FINCORP INVESTMENT RESEARCH Page 8

9 INVESTMENT RESEARCH Anil Kumar VP Research (+968) Joyce Monteiro Analyst (+968) Ext. 340 Mable Pereira Analyst (+968) Ext. 340 BROKERAGE/CUSTOMER CARE Abdullah Al Hinai Broker (+968) Ext: 334 Fax: (+968) Issam Ali Baqer Broker (+968) Ext: 332 Fax: (+968) Abdul Kareem Online trading (+968) Ext: 306 Muna A. Al Hashimi Customer care (+968) Ext: 330 Disclaimer The research team of The Financial Corporation, SAOG (hereto referred as FINCORP) has prepared the information, analysis and expressed its opinion on the subject matter of this report. The information contained has been obtained from sources believed to be reliable and in good faith, but which may not be verified independently. While utmost care has been taken in preparing the above report, FINCORP makes no guarantee, representation or warranty, whether express or implied, and accepts no responsibility or liability as to its accuracy or completeness of the data, being provided. All investment information and opinions are subject to change without notice. The investor will indemnify FINCORP and its directors, officers, and employees against any loss or damage or other liabilities (including costs), which they may suffer as a result of reliance on this report. This report is not to be relied upon in substitution for the exercise of independent judgment. Also, not all customers may receive the material at the same time. This document is for private circulation and information purposes only. It does not and should not be construed as an offer to buy or sell securities mentioned herein. FINCORP will not be liable for any direct or indirect losses arising from the use thereof, and the investors are expected to use the information contained herein at their own risk. FINCORP and its affiliates or their officers, directors and employees may own or have positions in any investment mentioned herein or any investment related thereto and from time to time add to or dispose of any such investment. FINCORP and its affiliates may act as market maker or assume an underwriting position in the securities of banking companies discussed herein (or investments related thereto), and may sell them to or buy them from customers on a principal basis and may also perform or seek to perform investment banking or underwriting services for or relating to those banking companies. Authors or contributors of this report could have direct interest in the capital market or in the securities mentioned herein. The investments discussed or recommended in this report may not be suitable for all investors. Investors must make their own investment decisions based on their specific investment objectives and financial position, and using such independent advisors, as they believe necessary. Income from investments may fluctuate. The price or value of the investments, to which this report relates, either directly or indirectly, may fall or rise against the interest of investors. This document is strictly for the use of recipients only. None of the material provided herein may be reproduced, rewritten, rehashed, published, resold or distributed in any manner whatsoever without the prior and explicit written permission of FINCORP. FINCORP INVESTMENT RESEARCH Page 9