GBCM Research. INVESTMENT UPDATE Bank Muscat BUY. Well Geared For The Ride

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1 INVESTMENT UPDATE Bank Muscat BUY 08 th April 2009 Share Data Well Geared For The Ride CMP MSM code BKMB Bloomberg code BKMB OM Market Cap (RO mn) Issued Shares (mn) 1, Performance (%) YTD 6m 12m Bank Muscat MSM 30 Index Core performance is expected to be dented on flat interest income and lower fee & commissions. At Operating level for FY09E the profits are expected to be 25.3% lower than FY08. This could result in adj. profits before extraordinary gains and provisions to be lower by 36.0% at RO Million. However, post adjustments, profits are estimated to grow by 23.9% to RO million during current year. Healthy levels of capital adequacy and lower levels of nonperforming assets to provide comfort in difficult times. Sale of HDFC bank to compensate any requirement of incremental provisions during the year. As of now NPA s have not started showing up, however we have built in 0.5% increase in NPA to GL during FY09 Valuations FY09E FY10E EPS-Reported (RO) EPS- Adj.(RO) BVPS (RO) excl assoc PER (x)-adj PBV (x) Convertible bonds are expected to be listed soon on MSM and this would provide an attractive yield of 12.3%. Meanwhile, the Bank is raising RO 60 Million (option to increase to RO 75 Million) through 8% subordinated bonds. On Weighted Fair Value of RO the stock provides an upside of 66.3% from current levels. At CMP, the stock is trading below its book value (PBV FY09E- 0.9X) provides compelling valuation and we recommend Buy on the stock. Major shareholders (%) Royal Court Affairs : 24.8% Dubai Financial Group : 15.0% HSBC A/C BoNY Intl : 13.1% HSBC A/C MoD Pension Fund : 6.6% Stock Performance Source: Bloomberg Bank Muscat: Financial highlights In RO 000 s E 2010E 2011E Net Interest Income 162, , , ,387 YoY growth -(%) 29.9% 0.8% 10.3% 7.3% Operating profit 158, , , ,255 YoY growth -(%) 48.4% -25.3% 16.2% 7.9% Adj. Net Profit 123,223 78, , ,832 YoY growth -(%) 46.2% -36.0% 28.7% 9.2% Reported Net Profit 93, , , ,832 YoY growth -(%) 11.2% 23.9% -12.6% 9.2% Total Assets 5,935,333 5,542,031 5,929,763 6,349,480 YoY growth -(%) 44.1% -6.6% 7.0% 7.1% Gross Loans 3,853,274 4,315,667 4,790,390 5,269,429 YoY growth -(%) 37.8% 12.0% 11.0% 10.0% Customer deposits 3,173,032 3,452,534 3,832,312 4,215,543 YoY growth -(%) 36.6% 8.8% 11.0% 10.0% Networth-Exl. Assoc. 714, , , ,088 YoY growth -(%) 13.9% 0.2% 6.5% 6.6% Source: Company Reports; GBCM Research

2 Bank Muscat Valuation Model We have valued Bank Muscat-ex Associates on a weighted basis SOTP Dividend Discount Model (50%) and SOTP Excess Rate of Return Model (50%). In terms of Associates Saudi Pak Commercial Bank (35.07% holding) is valued at market value of RO Million (as against carrying value of RO Million). Bank Muscat International Bahrain (49% Holding) is valued at 1.0X book value (RO Million), while Mangal Keshav Holdings (43% Holding) is valued at carrying value of RO Million. We believe that we are conservative in valuation of its associates and have built in erosion of market value. On the core basis, the Bank is estimated to generate an average RoAE of 16.1% for FY10E- FY14E. During this period, the model considers for equity dilution due to convertible bonds during the year FY12 & FY14, on basis of 1.5X book value for the respective years. Bank Muscat Valuation Matrix LTFV-RO SOTP DDM Valuation Model - RO SOTP - Excess Rate of Return Model - RO DDM- Excl. Associates RO Equity Valuation FV RO Saudi Pak Commercial Bank RO BMI, Bahrain RO Mangal Keshav,, India RO Sustainable RoE (%) 16.0% Book Value (FY09 E - RO) Cost of Equity (K- %) RO 10.7% Growth factor (g-%) 4.0% On fair value of RO 0.963, the stock would be trading at 1.4X FY09 BVPS (excl. associates). The Bank with over 40% market share of total commercial bank credit has got strong promoter background which provides attractive investment opportunity. Bank Muscat SAOG Page 2

3 Investment Rationale 8% subordinated bonds to have marginal impact on NIMs To raise over 60 Million through 8% subordinated bond issue The Bank is to Issue 7 year subordinated bonds with 8% coupon opening 8 th April 2009 till 7 th May The Issue size is of RO 60 Million with an option to allot additional RO 15 million in the event of over subscription. We believe the coupon rate to be attractive and have built in RO 75 Million to be raised through this issue. Bank s USD 250 Million EMTN (Libor+70 bps) listed on Luxembourg Stock Exchange is getting matured on 26th May We believe this subordinated bond issue to help the bank in effective replacement of liabilities with better capital adequacy and scope to build up its asset base. Also the timing is seen as appropriate with liquidity improving during the dividend season (Total Dividends from MSM 30 Index constituents during the month of March 2009 is RO million). The impact of 8% coupon rate on the interest margins is expected to ease, as it forms c.1.5% of the interest bearing assets as on 31st Dec 2008 and c.1.7% of total interest bearing liabilities as on 31st December 2008 excluding the EMTN. We believe with scale up of assets, the impact will be minimal on the net interest margins. However, this issue is expected to put pressure on the liquidity in the market and rate determinacy for any new issues among peers and leasing sector. FY09 earnings expected to see a dent due to fall in non-core performance FY09E Adj. net profit before extraordinary provisions or gains is estimated to be 36.0% lower at RO million as against adj. net profit before extraordinary provisions or gains FY08 of RO million. The lag in softening of interest rates is expected to have its impact only by later part of the year. For FY09, we have built-in lower spreads (down by 27 basis points to 2.98%). As a result, we have forecasted flat net interest income to RO million with over 40 bps fall in NIMs to 3.0%. During 2008, the Bank has benefited from robust growth in fee and commission income boosting the operating profits by 48.4%. This resulted in decline in cost to income ratio to 35.6% levels. We believe FY09 is going to be challenging in terms of growth in this segment. We have built in 45%, YoY fall in fees and commissions to RO million after which the cost to income ratio is expected to bounce back to 44.5% levels. Moving ahead we expect the bank to soften this down to average at 41.3% levels with improvement in NIMs and healthy non-core performance. We have factored in lower fees and commissions, the lowest in last five years as a percentage of its core assets. Under the said assumptions, Adj. net profit before extraordinary provisions or gains is estimated to be 36.0% lower at RO million as against adj. net profit before extraordinary provisions or gains FY08 of RO million. As per industry sources, Banks have not seen any alarming increase in NPA levels in Oman as of now. However, we have built in an increase of 0.5% NPA/GL levels to 3.0% for Bank Muscat during the current year along with provision coverage of 130.8% (avg.fy09e-fy12e). Exit from HDFC bank cushions FY09 performance HDFC Bank sale is est. to bring in RO Million. This is expected to take reported profits up by 23.9% to RO million As of 22 nd March 2009, the Bank had sold 81% holding in its Indian Investment HDFC Bank and is expected to book a pretax gain of RO 39 million. We believe the Bank to exit its investment in HDFC Bank entirely and book est. post tax gain of RO million (assuming same avg. price at which 81% was sold). In these difficult times of uncertainty, this will benefit the Bank to negate the possible impact of incremental provisions. In addition, we have considered 10% loss from market investments Bank Muscat SAOG Page 3

4 (Quoted investments- RO million as of 31st Dec 2008). After this the Bank is expected to report net profit of RO million during FY09, which is 23.9% higher compared to RO million reported during FY08. Convertible Bonds Attractive on Listing Convertible bonds provides attractive yield of 12.3%. We believe convertible bonds are attractive at face value of RO which the Bank has distributed and is expected to list soon on MSM. The mandatoryconvertible bonds will carry a coupon rate of 7% per annum. On maturity, the bonds will be converted to ordinary shares of the Bank by using a conversion price which will be calculated by applying 20% discount to 3 month average share price of the Bank prior to the conversion. Fifty percent of the bond amount will mature after a period of 3 years and the remaining after a period of 5 years from the date of issuance. Irrespective of the price, the Bond provides a yield of 12.3% at the face value of RO Based on a scenario of YTM adjustment on the Convertible Bond in the range of 7.4% to 6.8%, the price appreciation would work out to 17.5% to 20.0% gain on listing. 4/5/ /31/12 03/31/14 CMP (RO) No of Shares (Nos.) 1000 Convertible Bonds (Nos.) 30 Face Value of Convertible Bonds (RO) Interest Payment - per Annum (RO) Conversion Ratio-Stage I (X) Conversion Ratio- Stage II (X) Cash Flows 4/5/ /31/10 03/31/11 03/31/12 03/31/13 03/31/14 CMP (RO) No of Bonds (Nos) Interest from Bond (RO) Converted Share Value (RO) Cash Flows (RO) Yield (%) 12.3% Scenario Analysis Bond Yield (%) 12.3% 9.4% 8.0% 7.4% 6.8% 5.6% Return on Bond Price (%) 0.0% 10.0% 15.0% 17.5% 20.0% 25.0% Source: GBCM Research In our model we have considered a dilution, based on 1.5X book value during FY12E (RO 0.764) and FY14E (RO 0.780). For year FY12, we expect the dilution to be 16.4% (conversion ratio of 1.091) and for year FY14, we expect the dilution to be 13.8% (conversion ratio of 1.068). Bank Muscat SAOG Page 4

5 Credit addition seen lower than FY08 Aggregate commercial bank credit during FY08 has seen robust growth of 42.3% to RO Billion, a whopping addition of over RO 3 Billion. We believe with current market conditions, funding pressures to remain in private sector, which may lead to lower credit addition during FY09. Meanwhile government surpluses targeting infrastructure, industry and services sector would be the focus area of growth. In this scenario, we are positive on Oman s activities, as major portion is funded by fiscal initiatives and support. Oman s Banking sector, which is in midst of favourable environment with one among the lowest credit to GDP ratio of c.55% is ideal to look forward with low exposure to foreign assets. Oman s vision 2020 and five year plans emphasizes on economic diversification and sustainability. This comes with focused spending of RO Billion during seventh five year plan ( ) which is almost equivalent to its 2007 Nominal GDP of RO Billion and much higher than overall commercial bank credit of RO Billion. We strongly believe that the government to move ahead with its plan in line with seventh plan period estimates. Seventh Five Year Plan- Actual vs Planned (RO Million) 6,000 4,000 5,554 5,415 4,731 4,009 3,852 4,022 3,951 3,949 2, Actual Planned 9.5% CAGR (FY09E-FY12E) growth in gross loan books and 9.0% (FY09E-FY12E) growth in deposits We have built in 9.5% CAGR (FY09E-FY12E) growth in gross loan books and 9.0% (FY09E-FY12E) growth in deposits for Bank Muscat. In terms of credit addition, we are conservative with addition of average RO 464 million (FY09E-FY12E) for the coming years. In terms of credit to deposit ratio, we believe the Bank to have a higher credit to deposit ratio of 125%, as the regulation requires permitted lending ratio to be 87.5%, thus providing scope for higher credit to deposit ratio. Valuation & Recommendation We have excluded investments in associates for valuation purpose and core business is valued by Dividend Discount Model and Excess Rate of Return Model. In terms of Associates Saudi Pak Commercial Bank (35.07% holding) is valued at market value of RO Million (as against carrying value of RO Million). Bank Muscat International Bahrain (49% Holding) is valued at 1.0X book value (RO Million), Bank Muscat SAOG Page 5

6 while Mangal Keshav Holdings (43% Holding) is valued at carrying value of RO Million. For DDM & Excess Rate of Return Model, the Cost of Equity is derived from CAPM Model at 10.7% along with terminal growth of 4.0%. DDM model derives fair value of RO 0.819, While Excess Rate of Return Model derives fair value of RO On Sum of Parts (value of associates- RO 0.075), the weighted fair value is arrived at RO using 50% weight on each of the models. This provides an upside potential of 66.3% from current market price of RO Bank Muscat: SOTP-Dividend Discount Model 4/6/ /31/09 03/31/10 03/31/11 03/30/12 03/30/13 03/30/14 Expected Dividends (RO) NPV of Expected Dividends (RO) Cost of Equity (%) 10.7% Terminal Growth Rate (%) 4.00% NPV (Tr. Value) (RO) DDM Fair Value Per Share (RO) Associates value Per Share(RO) Sum Of The Parts -(RO) Current Market Price (RO) Upside potential (%) 39.1% Bank Muscat: SOTP ERR Model Excess Return Perpetuity (RO 000 s) Onwards PAT 93, , , , , , , ,443 less: Equity Cost 56,588 66,662 66,781 71,745 77,097 85,222 91,290 92,757 Excess Equity Return 37,143 49,467 34,730 39,088 47,340 46,043 53,951 45,686 Cumulated Cost of equity PV of Excess Return 38,156 45,895 29,103 29,583 32,360 28,426 30, ,853 Beginning BV of Equity 527, , , , , , , ,268 Cost of Equity 10.7% 10.7% 10.7% 10.7% 10.7% 10.7% 10.7% 10.7% PV of Excess Return Stage 160,883 PV of Tr. Value of Excess Return 342,385 Sustainable RoAE 16.0% Value of Equity 1,031,137 Terminal Growth Rate (%) 4.00% ERR Fair Value Per Share (RO) Associates value Per Share (RO) Sum of Parts Valuation (RO) Current Market Price (RO) Upside potential (%) 80.6% Weighted Fair Value Methodology Fair Value (RO) Weight SOTP Model - DDM -(RO) % SOTP Model - ERR/Residual Income Model - (RO) % Fair Value Per Share (RO) Current Market Price (RO) Upside potential (%) 66.3% Bank Muscat SAOG Page 6

7 Risk Analysis Bank Muscat Bank Muscat has scaled up its coverage in line with CBO requirements in good times to well over 138% which provides comfort on increase in NPA s. Bank Muscat: Asset Quality In (%) Provision Coverage 99.0% 101.3% 113.7% 126.8% 145.9% 138.8% NPA/GL 8.4% 7.3% 6.5% 4.8% 2.7% 2.3% Bank Muscat: Loan Book Maturity In (%) < 1year 26.4% 32.5% 34.7% 23.3% 1-5Year 30.9% 39.6% 36.3% 30.1% >5Year 17.4% 27.9% 29.0% 46.7% The Bank has brought down its NPA s to gross loans to 2.3% as at end of 2008, which is commendable considering the size of the loan book. We have factored in 3.0% NPA to Gross Loan in our model, although there is no alarming rise in NPA s in Oman, as of now. Meanwhile, Loan Maturity profile has moved from short term to longer term during Total Assets Geographical Distribution As a % of Total Assets In (%) Oman 81.6% 79.7% 80.4% 72.2% Other GCC 9.0% 9.1% 8.8% 15.7% Europe 1.2% 6.5% 5.4% 2.8% USA 3.5% 0.6% 0.3% 2.2% Others 4.6% 4.2% 5.1% 7.1% Bank Muscat s total asset exposure Ex-Oman is 27.8%, out of which predominantly 15.7% is in other GCC which mainly constitutes bank placements (9.4% of total assets). We have not witnessed any defaults from regional bank placements. Hence, this along with Oman s overall exposure of 72.2% provides comfort to risk levels. Geographical Concentration - Credit Book As a % of Total Loan Book As a % of Total Assets In (%) Oman 98.1% 96.4% 94.2% 93.0% 67.5% 59.9% 60.0% 57.5% Other GCC 1.1% 2.9% 4.0% 6.6% 0.8% 1.8% 2.5% 4.1% Europe 0.2% 0.0% 1.5% 0.0% 0.1% 0.0% 0.9% 0.0% USA 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% Others 0.6% 0.7% 0.3% 0.4% 0.4% 0.5% 0.2% 0.2% Geographical Concentration Placements With Bank As a % of Placements with Banks As a % of Total Assets In (%) Oman 22.2% 0.6% 6.9% 1.9% 3.5% 0.1% 1.0% 0.3% Other GCC 48.0% 40.5% 31.7% 52.8% 7.6% 7.2% 4.4% 9.4% Europe 6.2% 36.1% 31.7% 15.3% 1.0% 6.4% 4.4% 2.7% USA 2.2% 2.7% 0.9% 2.6% 0.3% 0.5% 0.1% 0.5% Others 21.3% 20.2% 28.8% 27.3% 3.4% 3.6% 4.0% 4.9% Bank Muscat SAOG Page 7

8 Credit Book: Sectoral Distribution % of Gross Loan In RO 000 s Services 107, , , , % 8.4% 7.7% 10.8% Manufacture 126, , , , % 7.0% 8.0% 7.3% Mining and quarrying 23,317 65, , , % 3.3% 7.5% 6.8% Financial institutions 91, , , , % 7.0% 7.6% 6.0% Wholesale and retail trade 42,716 47,480 77, , % 2.4% 2.8% 5.8% Real estate 26,149 56, , , % 2.9% 4.4% 4.9% Import trade 147, , , , % 6.5% 7.3% 4.2% Utilities 89, , , , % 5.9% 3.6% 3.5% Construction 68,060 70,485 76, , % 3.6% 2.7% 3.4% Transport 21,012 51,435 32,380 88, % 2.6% 1.2% 2.3% Government 17,097 13,805 17,821 25, % 0.7% 0.6% 0.7% Agriculture and allied activities 7,893 7,235 9,313 14, % 0.4% 0.3% 0.4% Export trade 3,923 3,642 7,210 2, % 0.2% 0.3% 0.1% Others 100, , , , % 6.4% 5.6% 5.2% Corporate Loan Book 872,153 1,120,845 1,665,915 2,357, % 57.4% 59.6% 61.2% Personal and Housing loans 609, ,359 1,129,648 1,495, % 42.6% 40.4% 38.8% Gross Loan 1,481,833 1,953,204 2,795,563 3,853,274 Investments Bank Muscat Bank Muscat s exposure to equities (excluding HDFC Bank) is only 0.7% of total assets as on 31 st Dec 2008, (or 6% of Networth). We have built in additional provision of 12% on account of drop in value of Available for Sale investments. Quoted Investments (RO 000 s) Excl HDFC Bank Foreign bonds 8,185 10,464 10,464 Corporate bonds 2,872 8,241 8,241 Govt. Bonds 16,286 53,167 53,167 Fixed Income Securities 27,343 71,872 71,872 Foreign securities 7,001 97,713 9,113 Financial services sector 7,723 9,208 9,208 Industrial sector 7,778 8,927 8,927 Other services sector 26,729 28,796 28,796 Equity Investments 49, ,644 56,044 Quoted Investments 76, , ,916 Impairment (2,753) (13,166) (13,166) Quoted Investments 73, , ,750 Impairments If Assumed From Quoted Equities Quoted Equities 46, ,478 42,878 % of Networth 7.4% 18.4% 6.0% Unquoted Investments Foreign Securities Local Secutrities Investment Fund Units Bank Muscat SAOG Page 8

9 Investments In Associates BMI-Bahrain Saudi Pak Commercial Bank Mangal Keshav Holdings Country Bahrain Pakistan India Bank Muscat s Holding (%) 49% 35.07% 42.96% Listed/Not Listed Not Listed Listed - Karachi Stock Ex. Not Listed Carrying Value (RO 000's) 65,668 17,880 9,355 Market Value of Holding (RO 000's) NA 6,907 NA Our Valuation 1X BV Market Value Carrying Value Source: Company Reports; GBCM Research Bank Muscat International (Bahrain) Balance Sheet Review Bank Muscat has 49% holding in Bank Muscat International Bahrain along with other promoters. Istithmar World 10% Royal Court Affairs of Oman 11% Overseas Investment P.S.C 20% 2007 Global Investment House 10% Bank Muscat 49% Global Investment House, 0.1 Istithmar % World, 10.0 % Royal Court Affairs of Oman, 11.0% Overseas Investment P.S.C, 20.0% 2008 Financial Assets Bahrain W.L.L, 9.9% Bank Muscat, 49. 0% During the year 2008, the Bank Muscat International raised its capital from BD 25 Million (RO Million) to BD Million (RO Million) through rights issue. The issue was raised at a premium BD after which the networth went up by 233.6% to BD Million (RO Million). Bank Muscat International : Balance Sheet Highlights (In RO 000's) Assets Var(%) Liabilities Var(%) Cash & Central Bank Balances 17,710 65, % Due to Banks & Fis 295, , % T-Bills - 9,613 - Customer Deposits 295, , % Due from Banks & FIs 249,185 69, % Med. Term Borrowings 82,274 46, % Loans & Advances 497, , % Other Liability 14,422 7, % Non Trading Investments 37,854 32, % Subordinated Liability 13,475 13, % Inv. In Associates 10,891 2, % Inv. In JVs Share Capital* 59,771 25, % Fixed Assets 9,808 2, % Reserves 71,537 13, % Total Assets 832, , % Total Equity 131,308 39, % * million shares of BD 1 each Source: Company Reports

10 The bank provides commercial banking services through eight branches in Bahrain and a branch in Qatar (QFC). Apart from this, the Bank has taken initiatives towards universal banking structure with presence in selected emerging markets. However, these initiatives are at nascent stage to be sizeable to get affected from the recent financial turmoil. Subsidiaries Diners Club Services W.L.L Fully Consolidated Diners Club Franchise in Bahrain, Syria and Yemen Also allows the Bank to extend operations to Iran, Iraq & Sudan Joint Ventures BMI Offshore Bank Limited Seychelles Money on Demand Holdings W.L.L (Bahrain) Equity Accounting Equity Accounting JV with Seychelles International Banking Corp. Ltd. BMI has invested USD 1 Million towards the share capital (as on 31 st Dec 08) of the JV JV with Nonoo Holdings W.L.L entered during April Provides mobile phone banking operations. BMI has invested USD 1 Million towards the share capital (as on 31 st Dec 08) of the JV Associates Gulf African Bank -Kenya Equity Accounting Islamic Bank incorporated in Kenya. BMI holds 21.33% in the Bank and during the year 2007, BMI has invested BD 2.4 million in the Bank Summit Development Group - Botswana Equity Accounting Gross Loans (RO 000's) Corporate 130, , ,241 Syndicated 102, , ,055 Retail 58,282 69,080 93, , , ,175 1BD=1.0212RO Summit is a holding company based in Botswana. BMI has commitment (40%) of BD 18.9 Million (USD 50 Million) towards a total capital of USD 125 Million). As of 31 st Dec 2008, BMI has invested BD 9.4 Million (USD 25 Million) BMI along with corporate and retail segment is also active in loan syndications. As on 31st Dec 2008, 42.0% of the total gross loans were towards syndications. % Composition -Gross Loans Corporate 44.8% 35.0% 39.4% Syndicated 35.2% 44.5% 42.0% Retail 20.0% 20.5% 18.6% As on 31st December 2008, the asset qualities in terms of NPA s to Gross Loans were low at 1.8% and the Bank has got coverage of 86.8%. % of Gross Credit Exposure by Region Bahrain 59% Other GCC 25% Europe 7% Asia 4% Americas 3% Africa 2% Source: Company Reports; Basel II Pillar III disclosures Provision Coverage (%) 88.4% 78.9% 86.8% NPA/GL 0.8% 1.1% 1.8% Bank Muscat SAOG Page 10

11 Bank Muscat International: Asset Quality (In RO 000's - 31st Dec 2008) Neither Past nor Due Past Due but Not Impaired Individually Impaired Due from Banks & FIs 247,309-2, % Loans 474,468 21,542 9, % Non Trading Inv. 646,424-3, % % Impaired to Total Exposure Bank Muscat International, as on 31 st December 2008 has capital adequacy of 20.51% which provides comfort on de leveraging pressure and any unlikely impairments. For the year 2008, BMI has reported net loss of RO million after provisions of RO million majorly towards credit losses. Net Interest Income grew by 61.7% to RO Million. Also the Net Fee & Commissions jumped up by 66.0% to RO Million. However, 107% increase in salary and other operating expenses, the operating profits ended almost flat at RO million. Bank Muscat International: Income Statement Highlights In RO 000 s Var(%) Interest & Similar Income 34,014 27, % Interest & Similar Expense 19,071 17, % NII 14,943 9, % Net fee & Commissions 3,841 2, % Other Income 1,362 1, % Operating Income 20,146 13, % Expenses 13,631 6, % Operating profit before Amort & Depn 6,515 6, % Depn & Amort % Operating Profit 5,746 5, % Net Impairment Loss on Fin. Assets (7,956) (671) % Share of Loss of Associates (374) (273) 37.1% Share of Loss of JVs (461) - Net Profit (Loss) (3,044) 4,982 NM Source: Company Reports We believe BMI is having very strong capital ratios which may not cause damage in the books of Bank Muscat. Saudi Pak Commercial Bank The Bank has provided RO million towards impairment of loss in investments in Saudi Pak Commercial Bank during the year This along with currency loss and share of loss from the Bank took total carrying value from RO million to RO Million. As per the bank, the valuation was done by an independent accounting firm and this would be carried out every year, as per accounting norms to determine any material loss in value. The difference between the carrying value and market value is c. RO Million. For the near term, the Bank has got a consolidation strategy in terms of creating a new corporate identity which will give a new image and brand value. Meanwhile, the Bank has also finalized its 5 years strategy for 2009 to The Bank has set an objective to attain a status among the top ten banks during the plan period through a combination of organic growth and acquisitions. With restructuring initiatives, we believe further impairments are unlikely, however if any during 2009 would be negated with gains from sale of HDFC Bank. Bank Muscat SAOG Page 11

12 Compelling valuation drives our outlook Liquidity concerns overdone The Banking sector in Oman is experiencing a period of flux While, there are signals of slowdown in Oman s credit market, we believe the major concern on part of Interbank rates have softened down faster as against the regional peers. Revision in reserve requirement and increase in permitted lending along with dollar facilities from central bank evaded concerns on liquidity. Its Growth Vs efficiency As of now Banks have become more stringent in lending norms while looking for space in corporate segment wherein there is scope for margin improvement. We believe spreads to bottom out during the year as presence of liquidity and low inflation rate would enable CBO to cut its reserve requirement again in the second quarter of the current year. We believe the Bank to focus on improving its RoE by improvement in margins and optimization of costs rather than focusing on aggressive credit addition. Bank Muscat has always been efficient in cross selling, thereby augmenting its fee & commission income growth. However the fee and commission income from investment banking for 2009 is expected to be lower as compared to previous year. Adequately Provided Lower credit addition will require lower general provisioning requirement as compared to previous year. Year 2008, the Bank has added RO Billion as gross loans along with general provisions of RO million (1.2% of credit addition) out of the total RO Million provisions. Bank Muscat has provided over 138% of its NPA s (2.3% of GL). We believe lower growth scenario would negate any incremental loan provisioning on the specific portion, unless we witness significant increase in NPA s in the banking sector. Is it skepticism or Value opportunity? Yes, we believe the bank which enjoys a leadership position with over 40% market share, in terms of commercial bank credit in Oman with credible promoter background is well placed to sustain any turbulence. The stock was beaten down 26.1%, YTD and over 70% during the last 12 month period. This was on back of global financial systemic jitters and concerns on low crude prices, regional real estate scenario, possible rise in non-performing assets and presence of toxic assets in the region. Bank Muscat has taken prudent measures for uncertain times. Unlocking of value in HDFC Bank is expected to act as a cushion during the year, wherein core performance is expected to be relatively lower. We believe our assumptions have been drawn on a very conservative scenario based on current market conditions. However, we believe local economic strength would drive valuations for Bank Muscat. Hence, the stock trading below its book value (PBV FY09E- 0.9X) provides compelling valuation and we recommend Buy on the stock. Bank Muscat SAOG Page 12

13 Bank Muscat Trailing PBV Chart Bank Muscat Forward PBV Chart Bank Muscat Trailing PE Chart Bank Muscat Forward PE Chart

14 Bank Muscat: Income Statement Highlights (Excl. Associates- 09E-12E) In RO 000 s E 2010E 2011E 2012E Interest Income 218, , , , , ,272 Interest expense 93, , , , , ,981 Net Interest Income 124, , , , , ,291 Other operating income 48,107 74,694 40,824 49,650 54,201 58,206 Net operating income 172, , , , , ,496 Operating expenses 66,240 78,487 85,896 92,502 99, ,967 Gain and loss from associate 5,499 (3,248) Profit before taxation 97, ,903 90, , , ,213 Taxation 13,450 14,680 11,267 14,502 15,833 17,777 Net Profit 84, ,223 78, , , ,436 HDFC Bank Sale Proceeds , Provisions on AFS - (10,929) (5,112) Impairment of Associates - (13,750) Impairment of Placements with Bank - (4,813) Reported Net Profit 84,257 93, , , , ,436 Bank Muscat: Balance Sheet Highlights (Excl Associates) In RO 000 s E 2010E 2011E 2012E Cash & Balances With CBO 487, , , , , ,639 Held to Maturity 32, , , , , ,039 Interbank Payments 587,802 1,077, , , , ,075 Investments 86, , , , , ,406 Gross Loans 2,795,563 3,853,274 4,315,667 4,790,390 5,269,429 5,690,984 Net Loans 2,686,863 3,727,700 4,151,520 4,601,260 5,059,269 5,468,071 Fixed Assets 19,090 21,948 23,045 24,198 25,408 26,678 Other Assets 217, , , , , ,726 Total Assets 4,118,024 5,935,333 5,542,031 5,929,763 6,349,480 6,829,635 Total Interbank Liabilities 663,236 1,412, , , , ,730 Total customer deposits 2,322,089 3,173,032 3,452,534 3,832,312 4,215,543 4,552,787 CD's, Bonds & FRNs 180, , , , , ,203 Total Other liabilities 315, , , , , ,434 Total Tier two capital 108, , , , , ,500 Total Tier 1 capital 627, , , , , ,883 Source: Company Reports; GBCM Research Bank Muscat SAOG Page 14

15 Ratio Analysis E 2010E 2011E 2012E Per Share Analysis (RO) Earnings Per Share ( Before Extraordinaries) Earnings Per Share (Reported) Dividend Per Share Book Value Per Share Profitability& Return Measures (On Adj.) (%) Return on Equity- Excl Associates 16.0% 19.8% 12.7% 15.2% 15.4% 15.7% Return on Average Equity- Excl associates 20.7% 21.4% 12.7% 15.7% 16.0% 16.4% Return on Assets - Excl Associates 2.0% 2.1% 1.4% 1.7% 1.7% 1.8% Return on Average Assets - Excl. Associates 2.4% 2.5% 1.4% 1.8% 1.8% 1.9% Net Interest Income / Avg. Assets 3.5% 3.2% 2.8% 3.1% 3.1% 3.2% Operating Profit / Avg. Assets 3.0% 3.1% 2.1% 2.4% 2.4% 2.5% Cost to Income 40.7% 35.6% 44.5% 42.5% 42.4% 41.8% Spreads (%) Yield on Interest bearing assets 6.6% 5.3% 6.0% 6.1% 6.1% 6.1% Cost of Funds 2.9% 2.1% 3.0% 3.0% 3.0% 3.0% Interest Spread 3.7% 3.2% 3.0% 3.2% 3.2% 3.2% Net Interest Margins 3.7% 3.4% 3.0% 3.2% 3.2% 3.3% Liquidity Measures (%) Liquid Assets / Total Assets 12.6% 10.4% 5.6% 5.6% 5.5% 5.4% Bank Borrowings / Total Assets 16.1% 23.8% 11.7% 9.7% 8.3% 8.3% Net Loans / Deposits 115.7% 117.5% 120.2% 120.1% 120.0% 120.1% Customer Deposits / Total Liability 56.4% 53.5% 62.3% 64.6% 66.4% 66.7% Credit Quality Indicators (%) Total Provisions / Gross Loans 3.9% 3.3% 3.8% 3.9% 4.0% 3.9% Provision Coverage 145.9% 138.8% 126.8% 131.6% 132.9% 130.6% NPA's / Gross Loans 2.7% 2.3% 3.0% 3.0% 3.0% 3.0% NPA's / Total Assets 1.8% 1.5% 2.3% 2.4% 2.5% 2.5% NPA's / Net Worth 11.9% 12.7% 18.1% 18.9% 19.5% 19.2% Source: Company Reports; GIS Research Bank Muscat SAOG Page 15

16 Institutional Sales - Hunaina Banatwala, (+968) Business Development - Sunil Dhall, (+968) Institutional Brokerage - Talal Al Balushi, (+968) Equity Research - Ajeev Gopinathan, (+968) Kanaga Sundar, (+968) Vijay Sridharan, (+968) Disclaimer: This document has been prepared and issued by Gulf Baader Capital Markets SAOC ("the Company") on the basis of publicly available information, internally developed data and other sources believed to be reliable. While all care has been taken to ensure that the facts stated are accurate and the opinions given are reasonable, neither Gulf Baader Capital Markets SAOC nor any employee shall be in anyway responsible for the contents of this report. The Company may have a position and may perform buying/selling for itself or its clients in any security mentioned in this report. This is not an offer to buy or sell the investments referred therein. Bank Muscat SAOG Page 16