Initiating Coverage on Emerging Banks

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1 Head of Research: Suresh Kumar.S. Tel: (+968) Analyst: Zeenat Kerawala Tel: (+968)

2 Summary Banking Sector Key Drivers Aggressive government spending to act as fuel towards growth Focus of government on non petroleum activities to boost lending The diversification and privatization activities to incentivize Banking sector thereby creating demand for corporate credit, trade financing, project financing, syndicated loans Growth in money supply and trade credit to create liquidity in the market Underpenetrated market and favorable demographics, to create scope for consumer and mortgage loans Emerging Banks Moving against the odds Emerging Banks slowly gaining their foothold in the local market Growing at a rate above the industry average, both in terms of advances and deposits Higher Efficiency and productivity Better Asset quality due to prudent risk based approach We initiate coverage on the Emerging Omani Banks, Ahli Bank and Bank Sohar ; we have a positive outlook on the banks taking into account their growth potential based on the aggressive expansion plans, advanced technological know-how and penetration in to various product segments in order to increase their fee income and build in and enhance relationships. Bank CMP (R.O) Target Price Upside Rating Ahli Bank % Accumulate Bank Sohar % Accumulate Page 2 of 38

3 Content Banking Sector at a Glance 4 Emerging Banks A Quick Review. 11 Growth Potential Justifies the higher valuations AHLI BANK SAOG - Executive Summary A Snapshot Investment Rationale Valuation Financial Summary BANK SOHAR SAOG - Executive Summary A Snapshot Investment Rationale Valuation Financial Summary Financial Highlights of the Emerging Banks Page 3 of 38

4 Banking Sector Replicating the Macro economic Factors The banking sector is closely related to the macroeconomic factors such as the GDP growth, government policies, money supply and trade balance, which act as major drivers towards the growth in the banking sector. GDP The Growth Indicator The economy has been growing phenomenally over the past few years as witnessed by the nominal GDP trend. The economic growth has been primarily driven by the revenues from the petroleum sector which increased by 38% from RO 4489 mn in 2007 (76% of the total revenues) to RO 6195 mn (79% of the total revenues) in Omani Banks being directly correlated with the economic growth were the biggest beneficiary of the economic boom. Relative Performance of Banking Sector v/s Oil Prices & Economic Growth Source: CBO & Al Maha Financial The overdependence of the economy on the hydrocarbon sector resulted in uneven economic growth. The impact of the volatile oil prices can be easily seen during the last quarter of 2008 and the first two quarters in 2009 which led to a deceleration in the economy growth. Movement of Economy v/s the Oil Price Source: CBO & Al Maha Financial Page 4 of 38

5 Aggressive Government Spending to encourage economic growth Oman is actively pursuing a development plan focusing on Diversification, Industrialization and Privatization with an objective of reducing the oil sector contribution to the GDP to 9% by 2020 (Vision 2020). In order to fulfill its objective, the government has been spending aggressively on tourism projects, infrastructure projects, agriculture and fisheries, and industrial sectors, in order to diversify its revenues through non - oil sectors, encourage xports and increase in productivity of various sectors, notably oil and gas sectors. Break up of Government Spending Source: CBO & Al Maha Financial The efforts of the government is well reflected in the growing contribution of non oil sector towards the country s GDP. Contribution of Oil & Non Oil Activities in GDP Source: CBO & Al Maha Financial Page 5 of 38

6 Economic Diversification As a part of its diversification plans the government is in the process of: Planning to establish a Free Trade Zone in Salalah. Undertaking new projects on gas based industries, tourism and other production and service sector. Undertaking mega industrial projects at Sohar Industrial Area, are Oman Polypropylene, Sohar Aluminum, Polyethylene, Methanol, Aromatic, Sohar Refinery, Sohar Urea, Shadeed Iron and Steel, and others. Undertaking major tourism projects currently under way include Al Mooj Tourism Resort, Yti resort, Blue City resort, Mirbat resort, Muscat Golf playground, Hayout resort, Al Seifa tourist complex, Shinas resort, Ras Al Hadd tourist village, Al Rawda tourist resort, the Wave, Salalah Tourism Centre, The Blue City, Zagi Resort, Muscat Golf, Salam Resort and Spa, Nur City, Musandam Course as well as various resorts in Shinas, Dibba and Mirbat, said the minister. Expanding country s two airports Seeb and Salalah. Set up airports at Sohar, Duqm and Ras Al Hadd. Privatization In accordance with the privatization policy the government has been divesting its stake in many stateowned companies and redirecting the revenues from divestment in financing productive projects. The government is targeting to liberalize many government old units, providing opportunities to private enterprises to build, own and operates public services and engaging the private companies and establishments to provide services on behalf of the government. The privatization and diversification policies accompanied by government spending will incentivize the banking sector thereby creating more demand for corporate credit, trade financing, project financing, syndicated loans thereby encouraging the banking activities. Moreover a range of opportunity will arise to fund the small and medium business sector that is expected to play lead role in Oman s future activities. Growing scope of FDI inflow The government has been taking initiatives to attract Foreign Investments in Oman. It has been undergoing vigorous privatization plans, establishing Free Trade Zones, and offering incentives to attract foreign investments in gas based projects, tourism projects and many other projects. It has also liberalized foreign investments norms, tax regimes, real estate, ownership options for foreigners, simplified business procedures, established transparent governance structure, etc. Apart from this a number of bilateral, regional and multilateral initiatives have been taken by Oman for protection and promotion of foreign investments. This has resulted into compounded growth of 126% in FDI investments in the country over FY 04 to FY Page 6 of 38

7 Growth in FDI Investments ($ Mn) Source: CBO & Al Maha Financial Credit rating agency Moody s has recently upgraded the Sultanate s government bonds and bank deposits (in foreign currency) sovereign rating from A2 category to A1 category. It has also raised the sovereign rating of the bonds issued (in foreign currency) from A3 to A2 category. The rating of bonds published in local currency remained unchanged at A2. The increase in Oman s ratings to the relative strength of public finances compared to other countries that got the same rating will help attract foreign investment into the country in various economic sectors and increase the confidence of local and foreign investors in the strength of the local economy. The expected FDI inflow will ensure enormous amount of capital inflow thereby enhancing production activities, create job opportunities, contributing towards economic growth. This will encourage saving activities among the corporate and local segment resulting in the growth in banking sector. Trade Balance and money supply The Sultanate has been witnessing robust growth in the fiscal position owing to the favourable oil price movement. A fiscal surplus indicates that the government is saving more than enough to finance all its operations and capital spending. Fiscal Surplus V/s Government Spending Source: CBO & Al Maha Financial Page 7 of 38

8 During FY09 the government planned 10.8% increase in the total expenditure to RO 6424 mn over the previous year budget. The government projected a budget deficit of RO 810 mn based on the conservative oil prices estimates of $ 45 / bbl. However, Oman booked a budget deficit of RO 22.1 mn, as supported by the recovery in oil prices and due to the growth in non oil sectors. The lower than expected deficit will encourage the government to continue its development activities at a faster pace. Moreover the government spending increases by 12% as per the FY10 budget to finance a range of infrastructure activities thereby expecting a budget deficit of RO 800 mn based on a conservative estimate of oil price at $ 50 a bbl and average daily production of bbls. Assuming the oil prices to average out at $ 75 / bbl, we expect a surplus of RO 1225 mn this year. All the above factors will boost infrastructure spending; accelerate economic growth thereby increasing liquidity and scope of investments in the Sultanate, providing scope for growth in the banking sector. Money Supply & Trade Credit The Liquidity Factor Broad Money (M2) an indicator of Money Supply has been showing a strong growth in the past. The growth in money supply has outperformed the GDP growth. It has grown 1.9 times the GDP during FY 09. The growth in M2 points to stability and liquidity in the economy which is expected to boost investments. However the total credit declined during FY 08 FY 09 as the banks were going slow on disbursing credit. But money supply (M2) and total credit continued to grow in the first quarter of 2010, by 9.09% and 5.8% respectively, at a moderate rate than the levels seen in 2008 in Oman and the GCC. The current moderate growth of M2 and total credit indicates a stable economic growth scenario. This was accompanied by positive real interest rates that price credit more realistically unlike during 2008, when real interest rates were negative. Lower M2 and total credit growth have encouraged lower inflation levels which will create stability and liquidity in the market thereby benefitting the Omani Banks. Growth in Money Supply and Credit v/s Inflation Sourcs:CBO & Al Maha Financial Page 8 of 38

9 Other Demand Drivers Under penetrated market Omani banking remains the under penetrated when compared to the other markets in the GCC region. It has the lowest credit to GDP ratio of 40% during FY08 which is due to lower population, lower literacy rate, and overdependence on the petroleum sector for the economic growth. The diversification towards non oil sector and improving demographics provides space for the Omani Banks to grow their loan book without stretching their balance sheet. Credit to GDP Ratio of Commercial Banks in Oman Credit to GDP Ratio of Banks in GCC Source: CBO & Al Maha Financial Demographic Trends to boost Consumer Lending The population in Oman during FY 09 was 2.87 mn of which 69% are Omanis. Of the total population 43% belongs to the age group of 0-14 years. A majority of youngsters will be ready to enter the work force in a few years. The government is also framing policies to increase the literacy levels and focusing on Omanisation in order to provide ample of job opportunities to the nationals. The growing literacy levels and employment will increase the deposit accounts with the banks. The extended families in Oman will give way to nuclear families which will create demand for consumer and mortgage loans. The above factors will provide an ample scope for the retail banking growth. Page 9 of 38

10 Performance at a Glance Omani Banking Industry Omani Banking Industry witnessed a significant growth during FY 09 when the global banks mainly in the western countries were busy repairing their balance sheets, infusing capital and recovering from the financial crises. The performance of Omani banks highlights the level of resilience of the sector towards the external shocks, efficiency, stability and sustainability. Having a glance at the FY 09 performance of the local banks individually, the matured banks, Bank Muscat, National Bank of Oman and Oman International Bank registered a subdued growth in the net profit on account of high provisioning requirements and lost their market share to a certain extent. Bank Dhofar reported a steady growth in its business, higher productivity and improved return ratios where as Oman Arab Bank proved its sustainability by maintaining high returns. The new entrants Bank Sohar and Ahli Bank who have recently forayed in to commercial banking business performed phenomenally well led by the growth in the business and market share and improved asset quality. Highlights of the Banking Industry during Q1 FY10 Oman s commercial banks total assets grew by 8.5% in the quarter Y-o-Y basis. Comfortable liquidity is seen in the market as cash and deposits of banks with the CBO has increased from RO Mn. to RO Mn. Bank lending for the current quarter rose by 5.7% to RO Mn. from RO Mn. during the same quarter previous year. Investments of banks in CBO CDs increased from RO 914 Mn. to RO 1,339 Mn. a growth of 46.5% Y-o-Y basis, whereas outstanding investments in foreign securities declined to RO172.2 Mn. from RO214.3 Mn. a decline of 19.6% Y-o-Y basis. Aggregate deposits (incl. foreign currency deposits) saw a year-on-year growth of 13.2% to RO 9,788.8 million from RO 8,650 million. Provisional Net profits dipped for the quarter to RO 64.4 Mn., compared to RO 79.9 Mn. in the same period of Provisions and reserve interest for the current quarter registered growth of 27% to RO298 million from RO Mn. during same period last year. The above performance has been contributed by the 17 banks in Oman which constitutes 7 local banks and 10 foreign banks. The local banks are currently serving 87% of the market in terms of advances and 85% share in terms of deposits. Page 10 of 38

11 Emerging Banks Moving against the Odds In our coverage, we have regarded Ahli Bank and Bank Sohar as emerging banks. Ahli Bank (formerly known as Alliance Housing Bank) has transformed from housing bank to a commercial bank in 2008 and Bank Sohar was established the year The emergence of both the banks has undoubtedly intensified the competition in the banking industry. They have been successful in making their presence felt by expanding their branch network and capturing decent market share in terms of both deposits and advances. Market Share of Local Banks Advances Q1 FY 10 Market Share of Local Banks Deposits - Q1 FY10 Source: Company Report & Al Maha Financial The emerging banks have been gradually increasing their hold in the market. They have goal to create a. in order to create niche for their products and services in the market, the banks will continue to play on Branch expansion Providing customized services Building up and maintaining relationships Introduction of wide range of products in the market Market Share Movement of Local Banks Advances Market Share Movement of Local Banks Deposits Gradually increasing Gradually increasing Source: CBO, Company Report & Al Maha Financial Page 11 of 38

12 Performance Speak We have carried out a comparative analysis of the emerging banks with the matured banks based on various parameters of growth, productivity, quality and efficiency, based on the last 3 years data. The analysis infers that the emerging banks are performing phenomenally well in the key areas thereby driving the growth in the sector mainly during Growth in Business Out performance against Industry growth in terms of Deposits The emerging banks have been growing more than two times its industry growth rate in terms of both disbursements and deposits. The banks successfully proved themselves prominent in attracting deposits by expanding their branch network, introducing various promotional activities thereby adding a horde of customers. This has helped Bank Sohar and Ahli Bank to grow their deposit base by 52% and 46% in 2009 compared to the previous year. Growth in Advances of Local Banks during FY 09 Growth in Deposits of Local Banks during FY 09 HIGHEST GROWTH AMONG THE LOCAL BANKS Source: Company Report & Al Maha Financial Out performance against Industry growth in terms of Advances The emerging banks have been active though cautious at the same time in lending to the retail segment. The banks were very flexible and adaptable as per the customer needs and customized products which lead to instant approval and quick disbursals. This has helped Bank Sohar and Ahli Bank to expand their loan books by 24% and 18% in 2009 compared to the previous year. Risk Based Prudent approach resulted in lower NPLs The emerging banks adopted prudent risk based approach in lending funds which ensured in maintaining asset quality thereby reducing delinquencies. This is reflected in the lower average delinquency ratios of Ahli Bank (0.25%) and Bank Sohar (0.15%) as against the local banks. The nimble footed approach of the banks helped them to incentivize the opportunities thereby leading to a growth in their loan book with lower NPL levels. Page 12 of 38

13 Average Delinquencies of the local listed banks over Source: Company Report & Al Maha Financial Aggressive Expansion Plans and Innovative Products The emerging bank has been aggressively expanding their branch network in order to dig out the potential from the local market. Ahli Bank added five branches and off site ATMs taking their branch network to twelve and ATM network to seventeen during the year Bank Sohar added three branches during the same period expanding their reach to fourteen branches. Moreover it has 14 on site ATMs, 15 offsite ATMs and free of charge access to over 500 ATMs under the Oman Switch located all over the country. The emerging banks have been developing innovative products and services to attract new customers with the customer friendly systems and techniques. They strive for client servicing and ensuring customer satisfaction which acts as an impetus towards growth. Again they are very cautious though aggressive while lending funds to both retail and corporate segment including the SMEs. The overall efforts of branch expansion accompanied by innovative products and prudent management approach will continue to help the emerging banks to, build and develop relations, grow their business, expand their profitability and develop quality asset base. Valuation of the Local Listed Banks The emerging banks are presently commanding higher valuations compared to the industry average. Bank Sohar is currently trading at the P/E multiple of 18.26x and P/BV multiple of 1.90x followed by the Ahli bank trading at a P/E multiple of 14.90x and P/BV multiple of 1.96x. We opine that the higher valuations of the emerging banks are justified by their growth potential. Valuation Matrix of the Local Listed Banks Bank Sohar Ahli Bank National Bank of Oman Bank Muscat Oman International Bank Bank Dhofar P/E* P/BV Source: Zawya, Al Maha Financial *Annualised Page 13 of 38

14 Jun-09 Jun-09 Jun-09 Jul-09 Jul-09 Aug-09 Aug-09 Sep-09 Sep-09 Oct-09 Oct-09 Nov-09 Nov-09 Dec-09 Dec-09 Jan-10 Jan-10 Feb-10 Feb-10 Mar-10 Mar-10 Apr-10 Apr-10 May-10 May-10 Al Maha Research Performance of banking stocks Ahli Bank has provided YTD returns of 15% which is highest among the local banking stocks; the stock has also shown a 36% return during FY 09. This reflects the outperformance of the stock against the Banking & Investment Index which provided annual return of 17% during FY 09. Bank Sohar provided YTD returns of 8.4% and annual returns of 77% during FY 09. This reflects the outperformance of the stock against the MSM index in the long run. Returns of the Local banks v/s Banking & Investment Index performance (1 Year) ABOB BKDB BKMB BKSB NBOB OIBB Banking & Investment Index Source: Gulfbase & Al Maha Financial Growth potential justifies the higher valuations Though both Ahli Bank and Bank Sohar are trading at higher P/E and P/BV multiples when compared with the local banks in the MSM, the growth potential of the emerging banks justifies the higher valuations. The emerging banks are expected to grow at about 20% during the financial year. With the PEG ratio less than one, we foresee further upside for both the banks. We therefore recommend an accumulate rating on both the stocks with a positive outlook and scope of growth. Source: Al Maha Financial Page 14 of 38

15 Challenges The emerging banks can face the following challenges in their operations in the highly competitive market space. Difficult to capture market share from the matured banks as they are already established. Higher Cost to Income ratio due to aggressive expansion Activities and higher operating cost. Aggressive lending activities might hamper the asset quality. Sacrifice of NIMs in order to capture the market. Higher Marketing expenses. Page 15 of 38

16 Ahli Bank SAOG CMP : RO Target Price :RO Rating: Accumulate MSM Ticker ABOB CMP Face Value (RO) wk High / Low (RO) / wk High / Low (dt.) / Equity Cap. (RO. mn) 71.2 Market Cap. (RO. mn) Share Holding Pattern as on 31 st Mar 10 Key Positives Ahli Bank to incentivize opportunities based on the strategic tie up with Alliance United Bank Prudent lending activities and higher mortgage component in its loan portfolio to keep the NPL ratio lower as compared to the industry levels. Bank to Focus on Fee Based income in order to reduce the effect on Profitability due to contracting NIMs. Growth in Low Cost deposits to keep the Cost to Income Ratio at lower Levels leading to growth in profitability. Expansion Plans to act as fuel towards growth. Ratios FY08 FY09 FY10E FY11E P/E P/BV Div Yield 3% 3% 4% 5% RoAE 7.1% 9.5% 11.0% 14.3% RoAA 1.6% 1.6% 1.5% 1.7% Coverage Ratio 387% 213% 144% 193% Relative Performance (%) MSM 30 ABOB ABOB over MSM 1 Month -8% -9% -1% 3 Month -8% 0% 8% 6 Month -2% 21% 23% 12 Month 17% 46% 29% Movement of ABOB v/s MSM 30 Index Risks & Concerns Growth in the retail lending might affect the NPAs. Change in the provisioning policy might hamper the profitability. However we have considered the effect of the same in our analysis. Outlook & Recommendation We are positive on the outlook of the bank on account of its capability to incentivize the big business opportunities with the collaboration of Ahli United Bank. At current market price of RO 0.250, the stock is trading at a P/E of 17x of FY 10 forward earnings. We have arrived at a target price of RO based on rolling P/BV multiple. We are bullish on the stock and recommend accumulate rating to 10% upside from the current price in 12 months. Financials (RO 000) FY08 FY09 FY10E FY11E Interest Income 22,967 28,088 35,263 45,123 Interest Expense 11,639 14,418 20,809 26,240 Net Int. Income 11,329 13,671 14,454 18,883 NIMs 3.1% 3.0% 2.6% 2.6% Fee Income 2,510 4,077 6,034 9,776 PAT 5,933 8,541 10,472 14,549 Cost to Inc. Ratio 51% 39% 37% 29% EPS BVPS Page 16 of 38

17 Ahli Bank A Snapshot Ahli Bank erstwhile Alliance Housing Bank, established in Oman during 1998 was GCC s first private sector housing bank. It was specialized in mortgage loans and value for money loans. The bank embarked itself into a full fledge commercial bank in January 2008 by entering into strategic tie up with a leading regional commercial bank, Ahli United Bank (35% stake holding) and World Bank Group member, International Finance Corporation (9.9% stake holding). The partnership with the Ahli United Bank has helped the bank to diversify its business portfolio from mortgage lending to consumer banking, private and premium segment, corporate and SME segment. The bank is currently operating in Oman with a network of twelve branches and has strength of 237 employees. The bank enjoys a market share of of 5% in terms of advances and 8.7% in terms of deposits as on March Riyal Omani Financed FY09 Riyal Omani Invested-FY09 Source: Ahli Bank & Al Maha Financial Investment Rationale Strategic Tie up with Ahli United Bank to Incentivize Business Opportunities The bank forayed into commercial banking business during 2008 by entering into a strategic alliance with Ahli United Bank (AUB), a Bahrain based bank. Ahli United Bank BSC (AUB) is a full fledged commercial and investment banking group, providing wealth management, retail, corporate, treasury, offshore and private banking services. The tie up not only provided technical and managerial expertise but extended support to Ahli Bank to execute big funding deals and mobilize low cost deposits through various products and schemes launched. This has helped Ahli Bank to expand its balance sheet to a great extent thereby witnessing growth in its bottom line. We expect the bank to continue expansion of its business with the support of AUB thereby leading to the overall growth in business. Expansion Plans to Create Path towards Growth The bank is planning to establish around branches depending on the potential demand prevailing in the selective locations in Oman. The major target will be the developing areas in Salalah, Sur, Nizwa, Ibri, where the development activities are taking place aggressively. The bank will be focusing on its core banking activities and improved service quality by providing internet banking and SMS banking facilities to its customers. Page 17 of 38

18 This will lead to customer satisfaction, create scope for expansion of its client base and provide opportunity to cross sell the products to its customers. Loan Book Grow at a CAGR of 34% over FY 07 FY11 Ahli Bank being an emerging bank, we expect its loan book to expand aggressively as against the industry. The loan book of the bank has been growing at a CAGR of 36% over FY 07 FY 09. This was on account of its branch expansion; tie up with the AUB and building up relations with the corporate clients. We expect the bank to grow its loan book at a CAGR of 34% over FY 07 FY 11 on the back of Increase in branches. Focus on the corporate and SME segment. Expansion in its retail client base. Favourable Macro economic factors. Break Up of loan Book Source: Ahli Bank & Al Maha Financial Focus on Consumer & Corporate Segment to Boost the Loan Book Ahli Bank previously being a housing bank, has a chunk of mortgage loan in its portfolio. At present, mortgage loans comprises of about 70 to 75% of the bank s consumer loan portfolio. However as per the CBO norms, the consumer & mortgage loans should not exceed 50% of its loan book out of which not more than 10% of the portion should comprise of mortgage loans. Break up of Loan Book FY09 Break up of Loan Book Q1 FY10 Source: Ahli Bank & Al Maha Financial Since the bank recently stepped into commercial banking business it got 5 year exemption from CBO to meet the specified requirement. In order to adhere to the CBO norm, the key focus area of the bank will be the retail and corporate & SME segment. Ahli Bank might go for further extension to adhere to the above norm as it will be difficult for the bank to drastically reduce the mortgage loans from its portfolio. We believe the bank to aggressively grow on corporate and SME lending thereby increasing the corporate loan component to 50% of its total loan portfolio. Page 18 of 38

19 Improved Asset Quality Since mortgage loans comprises major portion of Ahli Bank s loan portfolio, the delinquencies has been lower when compared to the local banks in Oman. In order to comply with the CBO law of increasing consumer loans in its portfolio, the bank will see the NPAs climbing towards north thereby pulling the delinquency levels upwards. Trend in NPAs & Delinquency Rate Delinquency Rate of local Banks NPL ratio has been rising gradually due to growing focus on retail lending. However prudent risk management approach will avoid steep rise in the ratio Source: Ahli Bank & Al Maha Financial This can be witnessed from the delinquency levels which escalated to 0.32% during FY 09 from 0.19% in FY 08, mainly due to defaults from the retail side. There were no defaults on the corporate side during the year. We thereby expect the delinquency levels to gradually rise to 0.45% by FY11 on the back of increase in disbursements to the retail segment and SME segment. Provisions to increase by FY 11 The coverage ratio steadily dropped down since FY 08 from 387% to 213% during FY 09. The ratio will further reduce during FY 10 to 144% as the bank has the three year exemption from the CBO to provide for its NPAs against its reserves. We expect the exemption to end by 2011, leading to a rise in coverage ratio to 193%. Movement of Loan Loss Provisions and Coverage Ratio Source: Ahli Bank & Al Maha Financial Page 19 of 38

20 Aggressive Approach towards Expanding the Deposits Base The bank aggressively worked on expanding its deposit base by capturing 5.1% of the market share and grew at a CAGR of 75% during FY 07 FY 09. The launch of new products and increase in the number of branches from seven to twelve during FY 09 resulted in 46% growth in deposits, the highest in the industry. Growth in ABOBs Deposits Source: Ahli Bank & Al Maha Financial The sufficient liquidity in the market will encourage saving activities thereby leading the deposit base to grow at a CAGR of 51% over FY 07 FY 11. The banks key focus area remained the CASA deposits, which increased it to 22% in FY 09 from 7% during FY 08. This helped the bank to reduce its cost of deposits to 3.5% during FY 09. We expect the bank to continue adding the low cost deposits in its portfolio resulting in increase in the CASA deposits component to 30% by FY 11. Trend in CASA Ratio Deposits Break up FY 09 Deposits Break up Q1 FY10 Source: Ahli Bank & Al Maha Financial Intense Competition to Contract NIMs The bank has been maintaining its Net Interest Margins (NIMs) around 2.6% - 3.1% during FY 07 FY 09. We foresee intense competition in the market among the local banks which will put the industry margins under pressure. We thereby expect the NIMs of ABOB to compress by 40 bps to 2.6% during FY Page 20 of 38

21 Movement of Net Interest Margins Source: Ahli Bank & Al Maha Financial Returns The bank has been successful in improving its returns for the past 3 years. We expect both RoAE and RoAA ratios to improve further to 14.3% and 1.7% respectively on the back of: Source: Ahli Bank & Al Maha Financial Focus on low cost deposits. Increase in market share. Efficient Cost management which will keep the Cost to Income Ratio at lower levels. Bank to Focus on Fee Based Income to contain the effect of lower Net Interest Income With the pressure on the NIMs, we expect many banks to focus on Fee Based activities like Trade finance business, Foreign exchange business which in turn can lead to the growth in fee income. We expect Ahli Bank to continue focusing on the non fund activities, thereby leading the fee income to grow at a CAGR of 40% during FY 07-FY11. This will increase the contribution of fee based income to 51% of its operating income by FY 11 from current levels of 23%. Growth. in Fee Based Income Components of Fee Based Income Growing Component of Fee Income Source: Ahli Bank & Al Maha Financial Page 21 of 38

22 Improved Cost to Income Ratio There has been significant improvement in cost to income ratio since 2007 from 54% to 39% in One of the primary reasons in the impressive performance is the efforts of the bank in mobilizing low cost CASA deposits and increase in employee efficiency rate. We expect the bank to maintain the cost to income ratio of 29% assuming the same strength to continue with increase in the CASA deposits component to 30%. Trend in Cost to Income Ratio Source: Ahli Bank & Al Maha Financial Page 22 of 38

23 Valuations & Outlook Rolling P/BV Band We have arrived to a fair value of the stock at RO based on PBV Valuation Method. At the market price of 0.250, the stock is trading at a PBV of 1.8x of FY 10E Book Value. The movement of the stock price is found in PBV band of 1.8x - 2.0x since December We value the stock at RO implying a P/BV of 1.95x of FY 11E book value x 1.8x 1.6x 1.4x 1.2x Jan-08 Mar-08 May-08 Jul-08 Sep-08 Nov-08 Jan-09 Mar-09 May-09 Jul-09 Sep-09 Nov-09 Jan-10 Mar-10 Page 23 of 38

24 Financial Statements & Ratios Income Statement Year ended 31st December (RO 000) FY08 FY09 FY10E FY11E Interest Income 22,967 28,088 35,263 45,123 Interest Expenses 11,639 14,418 20,809 26,240 Net Interest Income 11,329 13,671 14,454 18,883 - growth % 21% 6% 31% Fee-based Income 2,510 4,077 6,034 9,776 Other Non-interest Income Total Operating Income 14,235 17,897 20,724 29,032 - growth % 26% 16% 40% Operating Expenses - Staff Cost 4,042 4,361 4,710 5,181 - Other Operating Exp. 3,640 3,560 3,618 3,910 Pre-Provision Profits (PPP) 6,553 9,976 12,396 19,941 - growth % Provisions ,413 Profit Before Taxes 6,692 9,710 11,896 16,529 Taxes 759 1,168 1,424 1,980 Profit After Taxes 5,933 8,541 10,472 14,549 - growth % 44% 23% 39% Balance Sheet As on 31st December (RO 000) FY08 FY09 FY10E FY11E Share Capital 64,615 67,846 71,238 74,800 Reserves & Surplus 22,440 24,772 27,103 30,966 Deposits 319, , , ,458 Borrowings 42,364 43,013 49,320 58,511 Other liabilities & provisions 7,729 13,716 19,695 28,665 Total Liabilities 456, , , ,400 ASSETS Cash & Cash Equivalents 14, , , ,947 Advances 375, , , ,142 Investments 46,004 42,415 44,535 47,207 Due from Banks 10,116 7,209 6,488 5,839 Fixed assets 8,283 9,190 8,577 7,861 Other assets 1,937 4,862 5,992 7,404 Total Assets 456, , , ,400 Page 24 of 38

25 Ratios FY08 FY09 FY10E FY11E Basic Ratio (RO) EPS Book Value per share Asset Quality (%) NPA Coverage 387% 213% 144% 193% Delinquency Ratio 0.19% 0.32% 0.40% 0.45% Credit Deposit Ratio 117% 95% 97% 96% Profitability ratios (%) RoAE 7.1% 9.5% 11.0% 14.3% RoAA 1.6% 1.6% 1.5% 1.7% NIM 3.1% 3.0% 2.6% 2.6% Cost to Income 51.3% 39.4% 36.7% 28.8% Spread analysis (%) Yield on interest-earning assets 6.3% 6.1% 6.1% 6.2% Cost of funds 4.0% 3.3% 3.6% 3.5% Spread 2.3% 2.8% 2.5% 2.7% Valuation ratios (x) P/E P/BV Dividend yield 3% 3% 4% 5% Page 25 of 38

26 Bank Sohar SAOG CMP : RO Target Price : RO Rating : Accumulate MSM Ticker BKSB CMP Face Value (RO) wk High / Low (RO) / wk High / Low (dt.) / Equity Cap. (RO. mn) 100 Market Cap. (RO. mn) 206 Share Holding Pattern as on 31 st Mar 2010 Key Positives Aggressive expansion plans to boost the total business mainly the low cost CASA deposits. Increase in the CASA deposits component and lower cost of deposits to mitigate the negative impact of decrease in the assets yields. Penetration of the bank in to Investment banking activities to boost its Fee Income. Prudent risk management lending to keep the asset quality intact. Unique Business Model of SME lending to create new opportunities and build in relations thereby supporting the corporate lending growth. Ratios FY08 FY09 FY10E FY11E P/E NA P/BV RoAE -3.1% 7.9% 8.8% 10.0% RoAA -0.4% 0.9% 0.9% 0.9% Coverage 1273% 656% 480% 450% Relative Performance (%) MSM 30 BKSB BKSB over MSM 1 Month -8% -12% -4% 3 Month -8% -10% -3% 6 Month -2% -6% -4% 12 Month 17% 89% 72% Movement of BKSB v/s MSM 30 Index Risks & Concerns Aggressive approach towards lending might affect the asset quality. Higher marketing expense and branch expansion activities might shoot up cost to income ratio thereby affecting the profitability. Outlook & Recommendation Bank Sohar is looking forward to add 7 branches to its network expanding its reach to 21 branches by the end of this financial year The bank also is looking forward to enter the investment banking segment this year. This will help the bank to enhance its business and boost its fee income. We also expect the current partnership model of SME lending will prove fruitful thereby augmenting its corporate loan book. At current market price of RO 0.206, the stock is trading at a P/E of 21x based on the FY 10 earnings. We have arrived at a target price of RO based on rolling P/BV bands valuation method. We are bullish on the stock and recommend accumulate rating with 11% upside from the current price in 12 months. Financials (RO 000) FY08 FY09 FY10E FY11E Interest Income 33,010 52,683 56,490 67,850 Interest Expense 22,201 29,825 28,847 32,227 Net Interest Income 10,809 22,858 27,643 35,623 NIMs 1.9% 2.9% 3.0% 3.2% Fee Income 6,680 5,696 7,584 11,621 PAT (2,264) 8,022 9,729 12,109 Cost to Income Ratio 65% 54% 56% 58% EPS BVPS Page 26 of 38

27 Bank Sohar A Snapshot Bank Sohar SAOG (BKSB), established in March 2007 as a commercial bank is primarily engaged in corporate and retail banking activities within the Sultanate of Oman. The bank successfully emerged as the fourth largest bank in terms of assets by the year At present the bank has a network of 14 branches and 15 offsite ATM s. It has strength of 450 employees as on Mar Riyal Omani Financed Q1 FY 10 Riyal Omani Invested - Q1 FY 10 Source: Bank Sohar & Al Maha Financial Investment Rationale Expansion Plans to Create Path towards Growth Bank Sohar is looking forward to add 5 branches by June 2010 and 2 more branches by December 2010, thereby expanding its network to 21 branches. The expansion will take place in the key areas of Al Khuwair, Buraini, Rustaq, Ibri, Amerat, Kuriat (Off Sea beach), Batinah region based on the potential and development activities taking place in these regions. The branch expansion will help to grow its deposit base mainly the low cost deposits, expand the loan book thereby increasing the balance sheet size. Apart from this, the bank is planning to foray in to Investment Banking segment by the end of FY 10 and planning to tap the market with a unique strategy. The introduction of investment banking services will help the banks to develop and maintain relations with its clients leading to an increase its fee based income thereby expanding its bottom line. Loan Book to Grow at a CAGR of 19% over FY 08 FY 11 Bank Sohar has registered a tremendous growth in its loan book since inception. This can be witnessed by the highest growth in the loan book bank which highlights the aggressive approach of the bank towards disbursals. The growth was primarily achieved on account of branch expansion strategy, bonding relations based on immediate loan processing, efficient servicing and the range of products extended to the retail and wholesale segment. However we expect the bank to see relatively lower growth in their loan book due to growing competition in the market. This will result in the credit off take to moderately grow at a CAGR of 19% over FY08 - FY11. Page 27 of 38

28 (OMR '000) Al Maha Research Break Up of loan Book Consumer & Mortgage Loans Corporate Loans E 2011E Growth in the local banks loan book -FY09 BKSB registered highest growth in the loan book Source: Bank Sohar & Al Maha Financial Focus on Corporate & SME Segment to Boost the Loan Book Bank Sohar has been focusing on the corporate lending thereby gradually reducing the retail loan component from its portfolio. This can be seen in the growing share of corporate loans to 54% during FY 09 as against 51% in the previous year Break up of Loan Book - FY09 Break up of Loan Book Q1 FY10 Source: Bank Sohar & Al Maha Financial We expect the bank to continue to focus on the corporate and SME segment. The major focused area will continue to be the SME and medium sector corporate thereby catering to their financial requirements. The bank has a strategy of entering into a partnership model with the emerging corporate and participates actively in advising and providing them with innovative solutions in order to capitalize the available business opportunities. This leads to the close monitoring of their business activities which enhance relationships and thereby building in the quality portfolio. Sound Asset Quality Bank Sohar being a newly established bank has the lowest delinquencies in the industry. The bank has been successful in maintaining its asset quality as witnessed by the delinquency levels restricted at 0.10% during FY 09. One of the reasons for maintaining lower NPL for the Bank is the prudent risk management policies. Moreover, majority (around 80-85%) of its retail loan book consists of lending to government employees. Also the bank follows stringent norms while lending to the sensitive sectors like construction. However the growing focus on the SME segment can shoot up the delinquency rates for the bank. At the same time, the partnership model will enable the bank to keep a close watch on the sector thereby restricting the NPL ratio to 0.40% which is still at comfort levels when compared to the industry standards. Page 28 of 38

29 Trend in NPAs & Delinquency Rate Source: Bank Sohar & Al Maha Financial Higher Provisions to provide a comfort zone The bank maintains higher provisions as witnessed by the coverage ratio maintained above 600%. The higher coverage provides a cushion for the banks in case of assets turning bad and avoids sudden pressure on the balance sheet. Going ahead we expect the bank to maintain coverage ratio between 450% - 480%. BKSBs Movement of Loan Loss Provisions and Coverage Ratio Source: Bank Sohar & Al Maha Financial Deposits to grow at a CAGR of 30% over FY 08 FY 11 The bank has been successful in increasing its market share to 9.6% during the year 2009, as compared to 7.4% during FY08. The aggressive branch expansion, introduction of various prize schemes, promotional activities, and range of products offered, efficient and quality services extended to customers as an attempt of developing and enhancing customer relations have helped the bank to achieve the growth in market share. Page 29 of 38

30 (OMR '000) Al Maha Research Growth in Deposits S avings & Curre nt Ac c o unt Time De po s its 1,400,000 1,200,000 1,000, , , , , , , , , , , , , E 2011E The bank has seen a major growth in the low cost deposit which will remain a major focused area of the bank. We expect the bank to change its deposit mix thereby increasing the CASA component to 48% by FY 11. As an attempt to increase the CASA component, the bank is looking forward to add 7 branches to its network by 2010 will help them to increase their deposit base mainly the low cost deposits and enhance fee income. We there by expect the bank to grow its deposit base at a CAGR of 30% during FY 08 FY11. Trend in CASA Ratio Deposits Break up FY 09 Deposits Break up Q1 FY10 60% 50% 40% 30% 20% 10% 0% 48% 43% 35% 20% E 2011E Source: Bank Sohar & Al Maha Financial CAR maintained above CBO Norms The bank maintains the Capital Adequacy Ratio (CAR) of 12.99% during the quarter March 2010 which is well above the Central Bank s minimum requirement of 12%. In order to adhere to the CBO stipulated norm of maintaining the Capital Adequacy at 12% levels and to encourage disbursement activities, the bank might opt for the route of raising funds up to RO 50 mn through Tier 2 capital in two phases by FY 10 at a cost of 6-7%. We have not considered the amount to be raised through the tier 2 capital in the financials due to the lack of clarity on the exact amount the bank will raise in order to maintain the CAR levels during the year Page 30 of 38

31 Intense Competition to Contract NIMs We have seen a steep increase in the NIMs of Bank Sohar during FY 09. This was on account of growth in loan book, improved yield on assets, reduced cost of liabilities and improved balance sheet management. The growing competition will pressurize the NIMs of the Omani Banking industry. However we expect the bank will successfully sustain the NIMs on the account of Change in Deposit Mix Reduction of Cost of Funds Movement in NIMs Source: Bank Sohar & Al Maha Financial Bank to Focus on Fee Based Income to ease the effect of lower Net Interest Income The fee income of Bank Sohar has been growing at a CAGR of 11% over FY 07 FY09. As an attempt to boost its fee based income, the bank is looking forward to enter into investment banking segment by the end of FY 10. However the cost associated and the income through the investment banking business is not considered in the financials due to the lack of information on the bank s strategy. We expect the fee income to grow at a CAGR of 21% over FY 08 FY11, in view of the bank s efforts. Growth in Fee Based Income Components of Fee Based Income 50,000 40,000 30,000 20,000 10,000 - NII Fe e Inc o me Othe r Ope rating Inc o me 240 6,680 10, ,696 22, ,584 27, ,621 35, E 2011E 100% 80% 60% 40% 20% 0% NII Fe e Inc o me Othe r Ope rating Inc o me 1% 38% 61% 2% 20% 78% 2% 21% 77% 1% 24% 74% E 2011E Growing Component of Fee Income Source: Bank Sohar & Al Maha Financial Page 31 of 38

32 Improved Cost to Income Ratio Bank Sohar being a newly established bank, it has a higher cost to income ratio of 54% during FY 09. The higher ratio is on account of costs associated with branch expansion and other operating activities which is generally higher for a start up bank. We expect the bank to improve the ratio on account of increase in low cost deposits, lower staff related expenses and other operating costs and as a result a decline in the cost to income ratio to 48% by FY12. Movement in Cost to Income Ratio Source: Bank Sohar & Al Maha Financial Profitability & Returns Source: Bank Sohar & Al Maha Financial The bank has been successful in transforming itself to a profitable bank from a loss making entity. This was on account of the bank s improved yields on assets, reduced cost of funding, improved balance sheet management and improved cost of efficiency which helped it to achieve this metamorphosis. However the RoAE and RoAA are still at lower levels when compared to the industry trend. We expect the RoAE of the bank to improve to 10% by 2011 on the back of: Focus on low cost deposits. Increase in market share. Efficient Cost management which will keep the Cost to Income Ratio at lower levels. Higher Fee Based Income. Page 32 of 38

33 Valuations & Outlook Rolling P/BV Band We have valued Bank Sohar based on the Rolling P/BV valuation method and arrived at a fair value of RO Jan-08 Mar-08 May-08 Jul-08 Sep-08 Nov-08 Jan-09 Mar-09 May-09 Jul-09 Sep-09 Nov-09 Jan-10 Mar-10 May-10 At the market price of 0.206, the stock is trading at a PBV of 1.79x of FY 10E Book Value. The stock is moving in the PBV range of 1.5x - 2.0x since June We value the stock at RO implying a P/BV of 1.8x of FY 11E book value. 2.5x 2.0x 1.5x 1.0x Page 33 of 38

34 Financial Statements & Ratios Income Statement Year ended 31st December (RO 000) FY08 FY09 FY10E FY11E Interest Income 33,010 52,683 56,490 67,850 Interest Expenses 22,201 29,825 28,847 32,227 Net Interest Income 10,809 22,858 27,643 35,623 - growth % 111% 21% 29% Fee-based Income 6,680 5,696 7,584 11,621 Other Non-interest Income Total Operating Income 17,729 29,131 35,798 47,855 - growth % 110% 64% 23% 34% Operating Expenses 12,581 17,215 21,812 29,749 - Staff Cost 7,059 10, Other Operating Exp. 5,522 7,012 8,687 11,498 Pre-Provision Profits (PPP) 5,148 11,916 13,986 18,107 - growth % 131% 17% 29% Provisions 7,785 2,808 2,930 4,346 Profit Before Taxes (2,637) 9,108 11,056 13,760 Taxes (373) 1,086 1,327 1,651 Profit After Taxes (2,264) 8,022 9,729 12,109 - growth % -454% 68% 79% Balance Sheet As on 31st December (RO 000) FY08 FY09 FY10E FY11E LIABILITIES Share Capital 100, , , ,000 Reserves & Surplus -3,513 5,429 15,158 27,267 Deposits 638, ,487 1,054,690 1,250,566 Borrowings 90,234 21,400 16,050 17,655 Other liabilities & provisions 18,177 26,294 34,642 46,745 Total Liabilities 842,911 1,024,610 1,220,539 1,442,233 ASSETS Cash & Cash Equivalents 93, , , ,681 Advances 634, , ,932 1,065,318 Investments 25,788 61,690 80, ,286 Due from Banks 69,216 20,280 20,280 20,279 Fixed assets 13,730 14,340 16,014 18,645 Other assets 6,000 9,246 11,558 15,025 Total Assets 842,911 1,024,610 1,220,539 1,442,233 Page 34 of 38

35 Ratios FY08 FY09 FY10E FY11E Basic Ratio (OMR) EPS Book Value per share Asset Quality (%) NPA Coverage % 655.6% 479.7% 450.2% Delinquency Ratio 0.12% 0.24% 0.35% 0.40% Credit Deposit Ratio 99.4% 90.3% 85.7% 85.2% Profitability ratios (%) RoAE -3.1% 7.9% 8.8% 10.0% RoAA -0.4% 0.9% 0.9% 0.9% NIM 1.9% 2.9% 3.0% 3.2% Cost to Income 65% 54% 56% 58% Spread analysis (%) Yield on interest-earning assets 5.9% 6.6% 6.0% 6.2% Cost of funds 4.1% 3.7% 2.9% 2.8% Spread 1.8% 2.9% 3.1% 3.4% Valuation ratios (x) P/E NA P/BV Page 35 of 38

36 Peer Comparison We have compared Ahli Bank and bank Sohar based on the recent March 2010 results highlighting the performance of both the banks with respect to the key parameters. Parameter Ahli Bank Bank Sohar Advances Break up of Loan Book Deposits Low Cost CASA Deposits Asset Quality Net Interest Income & NIMs Operating Profit Net Profit Credit Off take grew by 39% during the quarter 2010 to RO 505 mn as against RO 364 mn during the same quarter During the quarter of FY 10, the Consumer & Mortgage loan component declined to 54% of the loan book from 65% during Q1 FY 09. Customer s deposits advanced by 47% during Q1 FY 10 to RO 487 mn from RO 332 mn during the corresponding quarter of the previous year. The CASA component increased to 22% during the quarter from 9% during Q1 FY09. The bank maintained the NPL ratio of 0.28% reflecting the strength in its asset quality. The bank reported a 42% growth in the Net Interest Income during the first quarter of this year to RO 4 mn as against RO 2.8 mn during the same quarter last year. The bank registered a 65% Y-o-Y growth during the quarter March 2010 to RO 5.66 mn vis-à-vis RO 3.42 mn during the same quarter of The operating Margins improved to 60% during the quarter as against 47% during the same quarter of last year. The bottom line rose by 123% to OMR 3.15 Million as against RO 1.41 mn during March Net loans and advances grew by 4.3% from RO 787 mn in the quarter endingmarch 09 to reach RO 821 mn during the same period ending 31st March During the quarter the corporate loan component in Bank Sohar s portfolio increased to 56% from 52% during the same quarter FY09. Deposits declined by 2.2% from 832 million in March 09 to reach OMR 814 Million in the same period. The CASA component increased marginally during the quarter of March 2010 to 32% from 31% during Q1 March The company maintained the NPL ratio of 0.35% reflecting the strength in its asset quality The Net Interest Income witnessed a significant improvement of 74.9% from RO 4.28 mn for the quarter ended 31st March 09 to RO 7.48 mn for the quarter ended 31st March 10. The operating income has increased by 79.7% from RO 4.66 mn in the first three months of last year to RO 8.37 million in the first three months of the current year. The bank continued with its focus on profitable growth achieving a Net Profit of OMR 2.83 mn during the quarter ended 31st March 10 as compared to a Net Loss of OMR 0.78 mn during the quarter ended 31st March Page 36 of 38

37 PO Box 1065 PC 117, Al Wadi Al Kabir, Sultanate of Oman Tel: , Fax: Telephone Contacts Research: Suresh Kumar Zeenat Kerawala Radhika Gadhia Institutional Sales: A. S. Kedarnath Steven Noronha Brokerage: Al Hadi Ahmed Ali Abdullah Al Hinai Page 37 of 38