May 6, 2020

Oman Banking Sector

 Credit growth to remain low-single digit in 2020 before picking up to an average of 6% over 2021-25e on Bank Rating faster GDP growth  Deposit growth likely to remain subdued on Government’s lower oil & gas revenues  Net interest margins expected to remain under pressure on falling interest rates Bank Muscat Accumulate  (BKMB) Cost of risk to rise in 2020 and remain inflated over our forecast horizon due to the current macroeconomic

scenario

Bank Dhofar (BKDB) HOLD • We revise our target prices and ratings on the Omani Banking sector as follows: Bank Muscat (BKMB) – National Bank of HOLD Accumulate, Bank Dhofar (BKDB) –HOLD, National Bank of Oman (NBOB) -HOLD, Sohar International Bank Oman (NBOB) (BKSB) –HOLD, Ahli Bank (ABOB) -HOLD and HSBC Oman (HBMO) –HOLD, based on forecast revision on the

current covid-19 pandemic and low oil price’s negative implications for Oman’s economy. Bank Sohar (BKSB) HOLD • Oman banks have characteristically high exposure to sovereign credit risk through sizeable holdings of Ahli Bank (ABOB) HOLD sovereign and central bank assets. This close link between the Government and operating environment for banks includes about a large proportion of government and public sector deposits. (at about 33% as at the HSBC Oman HOLD end of Feb’20). Furthermore, Oman banks are heavily reliant on government spending to drive credit growth. (HBMO) Government oil & gas revenues as well as credit growth will be negatively affected under sustained low oil

prices amid the ongoing COVID-19 crisis. • We expect credit growth levels to fall to low-single digit for 2020 but beyond that, we expect credit growth to pick up to a CAGR of 6% over 2021-24e on a faster domestic output growth, as forecasted by the World Bank. Various Government-led diversification efforts like Tanfeedh program are expected to drive non-oil revenue but Government revenues are nonetheless expected to be impacted by lower hydrocarbon revenues.

The new gas field (Khazzan Gas) capacity utilization is expected to provide support.

• The World Bank forecasts Oman’s real GDP to decline by 3.5%YoY in 2020, followed by an expansionary year

with real GDP output expected to pick up to 2.7% in 2021. The IMF also expects an average growth of 1.23%

over the period 2021-2024 which we believe will translate into a credit growth of about ~6% over 2020-2024e.

We believe that if oil prices remain at current levels, then Oman’s finances will decline resulting in a less favorable macroeconomic outlook. • Our positioning stance for local banks remains unchanged, with preference given to banks that have sound capital management policies, better credit supervision, and stronger liquidity profiles. Additionally, we believe any improvement in the macroeconomic growth outlook will likely provide an upside risk to our valuations. This is because our estimates are conservative and our target prices are based on significantly high cost of equity, based on Oman’s 10Yr International bond’s average mid-yield to maturity on YTD basis, and US risk premium, which we believe is justifiable to use given the USD-OMR peg. We have assumed spreads to remain under pressure given the liquidity squeeze and falling interest rates. Any improvement on the contrary is likely to provide an upside to our valuations. • A further deterioration in the macroeconomic situation warrants downside risk to our valuation as it will have a direct negative impact on credit growth. Furthermore, deposit growth constraints might put more pressure on cost of funding. • The sector is currently undergoing a consolidation phase with Oman Arab Bank (OAB) in the process of merging with Alizz Islamic Bank (BKIZ). We believe that consolidation efforts will continue, and are necessary in an over-banked market like Oman. Last Px Target Price Upside / Current P/B'20e, P/E'20e, ROE'20e, Cash Div Implied Name (OMR) (OMR) (Downside) (%) P/B (x) (x) (%) Yield, % P/B (x) Bank Muscat 0.324 0.370 14% 0.59 0.54 6.06 9.1% 9.3% 0.62 Bank Dhofar 0.104 0.097 -7% 0.59 0.58 11.62 5.0% 2.9% 0.54 NBO 0.157 0.172 10% 0.58 0.60 6.48 9.1% 6.4% 0.66 Bank Sohar 0.082 0.080 -2% 0.59 0.57 6.67 8.8% 7.3% 0.56 Ayisha Zia Ahli Bank 0.120 0.126 5% 0.75 0.72 6.99 10.5% 8.3% 0.75 Research Analyst HSBC Oman 0.094 0.101 7% 0.57 0.52 8.68 6.1% 6.8% 0.56 [email protected] Average 0.61 0.59 7.75 8.1% 6.8% 0.61 Tel: +968 24 94 90 36 Source: Bloomberg, U Capital Research

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Contents

Local Peer Group Analysis ...... 3

Macro & Sector Outlook ...... 12

Valuation ...... 16

Risks to Valuation...... 16

Peer Group Multiples ...... 17

Sensitivity Analysis ...... 18

Bank Muscat SAOG ...... 20

Bank Dhofar SAOG ...... 23

National Bank of Oman SAOG ...... 26

Sohar International Bank SAOG ...... 29

Ahli Bank SAOG ...... 32

HSBC Bank Oman SAOG ...... 35

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Local Peer Group Analysis

Oman banks’ operating environment has potentially become more challenging due to Covid-19 as well as depressed oil prices. All banks have considerable exposure to sovereign credit risk through sizeable holdings of sovereign/central bank assets. The banks rely on government spending to drive credit growth and at the same time banks include a large proportion of government and public sector deposits in the system. The operating environment in Oman remains depressed for 2020, however, growth prospects improve during 2021-2024e based on the GDP growth pick-up expected by the World Bank. Nonetheless, banks remain exposed to the risk of fiscal policy remaining restrictive and oil prices remaining low. Opportunities for the banks to finance government-related projects will likely reduce and we expect overall sector loan growth to remain muted in 2020, only to pick up beyond 2020. Weakening of banks’ performance and asset quality is also highly likely. Oman banks have negative interest rate gap for 2020; a higher level of CASA deposits beyond 2020 is king Over the next 12 months (starting from 31st Dec 2020), all six listed conventional banks’ interest rate gap is negative, indicating that as interest rates decline, the bank's liabilities are repriced at lower rates. In this scenario, net interest income for 2020 is expected to increase for 2020 for some banks, whilst performing loans are preserved. However, as outlined below, asset quality is expected to decline under the current macroeconomic outlook resulting in pressure on net interest income realized for this year. Oman Banks: Interest Rate Gap -18% -18% -13% Non-interest sensitive -36% -21% -38%

23% 12% 20% Over 1 Year 22% 8% 17%

-13% -5% -24% 1-12 Mths -3% -9% -8%

8% 11% 17% Within 1 Mth 17% 22% 29%

-50% -40% -30% -20% -10% 0% 10% 20% 30% 40%

BKMB BKDB NBOB BKSB ABOB HBMO

Source: Bank Financials for 2019, U Capital Research

Amongst banks, National Bank of Oman (NBOB) has the largest negative interest rate gap over the next 12 months at 24%, distantly followed by Bank Muscat (BKMB) at 13%, Ahli Bank (ABOB) at 9%, HSBC Oman (HBMO) at 8%, Bank Dhofar (BKDB) at 5% and lastly Sohar International Bank (BKSB) at 3%.

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It is worthwhile to note that all banks also have a negative gap in non-interest sensitive assets, indicating support to interest income from non-interest sensitive liabilities in times of falling interest rates, as cost of funding is supported. HBMO and BKSB sport large chunks of their assets funded by non-interest sensitive liabilities. However, beyond 2020, we expect interest income to come under pressure from falling interest yields on assets. Banks with higher funding from non-interest bearing liabilities are expected to fare better than the others.

Oman Banks: Deposit Mix 2019

6000 60.8% 5000

4000 39.2% 3000

2000 58.2% 58.4% 66.2% 41.8% 54.5% 41.6% 45.5% 64.9% 1000 35.1% 33.8%

0 BKMB BKDB NBOB BKSB ABOB HBMO

CASA Term & Others

Source: Bank Financials, U Capital Research

HBMO sports the largest CASA % of total deposits at 66.2%, whereas ABOB has the lowest at 35.1%. In fact, for all banks except ABOB and BKDB, CASA % is more than 50%. We believe that in times of falling interest rates, a higher dependence on low-cost deposits helps to sustain a low cost of funding and supports income. Oman Banks: Net Spread

6.00%

5.00%

4.00%

3.00%

2.00%

1.00%

0.00% BKMB BKDB NBOB BKSB ABOB HBMO

Yield on Assets Cost of funds Net Spread

Source: Bank Financials, U Capital Research (based on our own calculations)

• Profitability ratios at a glance

A rush to preserve capital adequacy ratios whilst remaining competitive in loan growth has led many banks to raise Tier 1 Perpetual Notes as customer deposit growth remained muted. While expected to boost income in the longer run

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through growth in loans, the interest payments on these instruments has negatively affected profitability ratios of most banks. It must be noted this interest is paid through equity directly and does not affect income through cost of funding. Oman Banks: Return on Average Assets, 2019

1.60% 1.40% 1.20% 1.00% 0.80% 0.60% 0.40% 0.20% 0.00% BKMB BKDB NBOB BKSB ABOB HBMO

Return on Average Assets RoAA (after Interest on Tier 1 Perpetual Notes)

Oman Banks: Return on Average Shareholders' Equity, 2019

14.00%

12.00%

10.00%

8.00%

6.00%

4.00%

2.00%

0.00% BKMB BKDB NBOB BKSB ABOB HBMO

Return on Average Equity RoAE (after Interest on Tier 1 Perpetual Notes)

Source: Bank Financials, U Capital Research

• COVID-19 Impact likely to affect banks with economic sector concentrations

Amongst the listed conventional banks, HSBC Oman (HBMO) has the highest exposure (at 69% of its total gross credit portfolio) to the corporate & commercial sector, as of FY19-end. Within its corporate & commercial exposure, HBMO has the highest exposure to import trade and manufacturing sectors.

The listed conventional banks' exposure to the services sector is also high, with highest exposure of Sohar International (BKSB) at 15% of its portfolio, followed by Bank Muscat (BKMB) at 9%, NBO and Ahli Bank (ABOB) at 8% each, HBMO at 7% and Bank Dhofar (BKDB) at 6%. Overall sector exposure is at 8%. ABOB, BKDB & BKSB's exposure to the construction sector is also relatively high as compared to the sector.

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Oman Conventional Banks: Corporate Credit Concentration 100% 6% 8% 7% 8% 15% 80% 9% 1% 8% 5% 60% 6% 13% 6% 2% 40% 17% 4% 22% 6% 20% 15% 13% 4% 3% 2% 0% 0% 0% BKMB BKDB NBOB BKSB ABOB HBMO

Import trade Construction Wholesale and retail trade Services

Oman Conventional Banks: Credit Concentration

100%

80% 53% 58% 60% 65% 65% 69% 60%

40%

47% 20% 42% 40% 35% 35% 31%

0% BKMB BKDB NBOB BKSB ABOB HBMO

Personal and consumer loans/housing loans Corporate and commercial

Source: Bank Financials, U Capital Research

We expect borrowers in the tourism, transportation, trade, real estate and construction sectors to be most affected by the covid-19 outbreak, especially SMEs. In our view, the manufacturing sector might also face pressure due to supply chain issues amid country lock-downs and/or self-isolation.

Credit exposure at the individual borrower level is also not shielded from the virus impact either, with many banks having already announced suspension/deferral of interest payments, as per the Central Bank of Oman (CBO)’s directive. The CBO has asked banks to allow Omani nationals who have taken loans from them the option of deferring repayment for a three- month period, if their salaries have been reduced due to the covid-19 pandemic.

CBO's directive is in line with the Supreme Committee's drive to assist Omani nationals during the current ongoing crisis situation. However, depending on the number of Omani nationals who have had reduction in salaries, Oman banks' interest income is bound to come under pressure due to the deferment of interest and principle re-payment for 3 months effective from the date of salary reduction (date of postponement or commencement). The CBO has mandated free-of- charge deferment and has directed banks to work towards rescheduling the loans or financing if necessary.

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Furthermore, the 3-month postponement shall be from the date of commencement of the postponement, and the decision shall commence from the time the wages for the month of May are received, until further notice. Therefore, this 3-month postponement will be on a rolling basis as and when Omani nationals' salary reduction comes into effect starting from May, until further notice.

It is difficult to estimate the exact financial impact on banks as the number of Omani nationals with loans outstanding and salary reduction is unknown. However, it suffices to say that it is bound to have an impact on banks' carrying value of the relevant affected loans under IFRS 9 as delay in interest and re-payment needs to be accounted for.

Heat map for economic sector exposure BKMB BKDB NBOB BKSB ABOB HBMO Sector* Personal and consumer loans/housing loans 42% 40% 47% 35% 35% 31% 39% Corporate and commercial 58% 60% 53% 65% 65% 69% 61% Import trade 4% 3% 2% 0% 0% 13% 4% Construction 4% 17% 6% 15% 22% 6% 9% Export Trade 0% 0% 0% 0% 0% 0% 0% Manufacturing 8% 6% 8% 9% 5% 13% 8% Wholesale and retail trade 2% 1% 6% 13% 8% 5% 4% Electricity, gas, water 7% 5% 5% 3% 6% 5% 6% Transportation and communication 8% 0% 3% 2% 3% 5% Services 9% 6% 8% 15% 8% 7% 8% Mining and quarrying 6% 0% 2% 2% 5% 11% 5% Others 1% 10% 3% 0% 1% 8% 3% Financial Institutions 5% 5% 10% 3% 7% 0% 6% Real Estate 4% 0% 0% 0% 0% 0% 0% Government 0% 8% 0% 0% 0% 0% 1% Agriculture & Allied Activity 0% 0% 0% 0% 0% 0% 0% Non-resident 0% 0% 0% 1% 1% 0% 1% Total 100% 100% 100% 100% 100% 100% 100% Source: Bank Financials, 2019 and CBO

*Sector is Conventional Banks only, ex-Islamic Financing; All banks include Islamic Finance, if applicable

• Oman banks boast robust capital adequacy

Oman banks boast ample capital adequacy levels as at Dec-end 2019. The CBO has announced lowering Capital Conservation Buffers (CCB) from 2.5% to 1.25% as a policy measure to support banks in the context of the prevailing economic condition.

We believe that this is positive for banks in order to remain above minimum regulatory requirements if, in case, their capital takes a hit due to higher provisioning requirement for expected credit losses for financial assets transitioning from

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Stage 1 to Stage 2 and from Stage 2 to Stage 3. Any deterioration in asset quality is expected to negatively affect capital adequacy levels. Oman Banks: Capital Adequacy, 2019

22.0% 19.8% 20.0% 19.0% 18.6% 18.8% 17.9% 18.0% 18.1% 18.0% 17.1% 17.1% 17.1% 16.4% 16.7% 15.8% 16.2% 16.0%

14.0%

12.0%

10.0% BKMB BKDB NBOB BKSB ABOB HBMO Simple Average

Tota Capital Adequacy Ratio (CAR) Tier 1 Capital Ratio

Note: Banks are required to maintain minimum capital adequacy ratio of 13.50% including capital conservation buffer for 2019 (2018: 12.875%) in accordance with CBO stipulated guidelines. Under the new policy measures, minimum is 11% + 1.25% = 12.25%. Source: Bank Financials 2019, U Capital Research

However, falling capital adequacy levels might result in dividend pay-outs to be negatively affected for 2020 and beyond. Furthermore, Sohar International and Ahli Bank’s core equity T1 (CET1) ratios are just above the minimum regulatory requirement and lowest among the peers. Therefore, we believe that any material deterioration in asset quality or net profits for these banks for 2020 will likely result in CBO disallowing dividend payments for the year 2020. Oman Banks: Core Equity Tier 1 (CET1) Ratio, 2019

19.0% 18.0% 18.0% 18.0% 17.0% 16.0% 15.0% 14.0% 13.7% 12.6% 13.0% 12.3% 12.0% 11.0% 10.6% 10.6% 10.0% BKMB BKDB NBOB BKSB ABOB HBMO Simple Average

Source: Bank Financials 2019, U Capital Research

• Banks’ Asset Quality at a glance

Oman's listed conventional bank data indicates that over 70% of total of each bank's exposure is in Stage 1 of impairment or in simpler words, are performing or non-credit-impaired.

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Oman Banks: Stages of impairment of exposure as % of Total Loans

90.0% 81.4% 80.3% 80.1% 78.3% 80.0% 76.3% 73.8% 70.0% 60.0% 50.0% 40.0% 30.0% 25.2% 20.4% 23.4% 17.9% 16.7% 20.0% 13.8% 4.8% 4.9% 10.0% 1.7% 3.2% 3.2% 2.8% 0.0% BKSB ABOB HBMO NBOB BKMB BKDB

Stage 1 Stage 2 Stage 3

Source: Bank Financials 2019, U Capital Research Note: HSBC Oman does not have an Islamic window

All exposures are adequately provided for, with provision cover for non-performing loans (NPLs) at a simple average of 0.98x for the six banks. HBMO and ABOB are both carrying high provisions (higher than NPLs).

Oman Banks: NPL Provision Cover, (x)

1.14 1.14 1.05 0.98 0.93 0.82 0.78

BKMB BKDB NBOB BKSB ABOB HBMO Simple Average

Note: HSBC Oman does not have an Islamic window Source: Bank Financials 2019, U Capital Research

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Oman Banks: Total Provision as % of Total Loans & Islamic Financing

6.0% 5.1% 5.0%

4.1% 3.9% 4.0% 3.5% 3.6% 3.1% 3.0% 2.0% 2.0%

1.0%

0.0% BKMB BKDB NBOB BKSB ABOB HBMO Simple Average

Note: HSBC Oman does not have an Islamic window Source: Bank Financials 2019, U Capital Research

Oman Banks: NPLs as % of Gross Loans & Islamic Financing

6.0%

4.9% 4.9% 4.7% 5.0% 4.5% 4.0% 4.0% 3.3% 3.0%

2.0% 1.7%

1.0%

0.0% BKMB BKDB NBOB BKSB ABOB HBMO Simple Average

Note: HSBC Oman does not have an Islamic window Source: Bank Financials 2019, U Capital Research

Overall, NPL ratio (non-performing loans & Islamic financing to gross loans & Islamic financing) is low for the sector (as compared to its GCC counterparts), although it has climbed up over the last few years. We believe that we might see pressure on NPLs due to the ongoing economic situation over the short to medium term until the situation eases. CBO has introduced a new policy to protect banks by allowing them not to risk classify loans pertaining to government projects for a period of 6 months. We believe this measure should support banks.

• Net fee income growth has been capped temporarily to new loan origination; BKMB & BKSB have the highest share of operating income as net fee & commission income

Net fee income as a share of total operating income is highest for BKMB and BKSB at 21.7% and 18.5% respectively. However, ABOB’s net fee income forms the largest share of its total other operating income. Nevertheless, with CBO’s

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latest directive to banks to decrease existing fees and not introduce any new fee for 2020, we expect to see net fee income to remain under pressure for this year.

Oman Banks: Net Fee Income 78.7%

65.9% 67.8% 57.1% 58.7%

40.5% 42.1%

21.7% 18.5% 15.3% 14.3% 15.6% 10.9% 12.7%

BKMB BKDB NBOB BKSB ABOB HBMO Simple Average

Net fee income / Other operating income Net fee income / Operating Income

Source: Bank Financials 2019, U Capital Research

• Oman banks’ exposure to UAE’s troubled NMC Health

Oman banks disclosed that they have limited direct and indirect exposure to UAE’s NMC Health. The following table summarizes their exposure:

Exposure, OMRmn % of Assets Bank Muscat 0 0 Bank Dhofar 0 0 NBO 0 0 Sohar International Bank 3.45 0.1 Ahli Bank 0 0 HSBC Oman 6.2 0.2 Source: MSM

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Macro & Sector Outlook

Discouraging macroeconomic outlook amid the Great Lockdown and significantly low oil prices Oman has had extraordinary economic development since 2004, primarily due to the exploitation of its oil reserves. However, growth rates declined in 2019 to 0.5% as oil production remained capped by the OPEC+ production cut agreement amid a slowdown in household consumption. According to the updated World Bank forecasts in April 2020, Oman’s economy is expected to contract in 2020 due to the oil price slide and COVID-19 public health response. An increase in gas output and infrastructure spending plans will help growth to recover over 2021-22. Fiscal and external deficits will remain under strain due to low oil and gas prices. Rigid recurrent spending will keep public debt high, estimated to exceed 70% of GDP in 2020 and beyond. Stepping up efforts to diversify the economy and fiscal base would improve the outlook. As has been the case for many years now, the government is focused on economic diversification. Over the longer term, pro-business reforms such as the foreign ownership law and the FDI law are expected to increase trade and investment opportunities.

Oman Real GDP growth (%) Gross Fixed Capital Investment Growth (%)

2.5 2.3 1.8 1.8 1.6 5.7

2.8 2.5 2.7 -0.4 1.8 0.3 0.5 2014 2015 2016 2017 2018 2019e 2020f 2021f

-3.5 -4.3 -5.1 2015 2016 2017 2018 2019e 2020f 2021f 2022f

Source: World Bank Economic Outlook, April 2020 (e = estimate, f = forecast) Note: At constant prices

The World Bank cites long-lived oil price crash, which would require higher domestic and external borrowing, in turn needing more settled conditions in sovereign bond markets as key risks to Oman’s outlook. Current & Fiscal deficits are expected to increase As per the World Bank, fiscal rigidities have made consolidation difficult. The fiscal deficit is estimated to have remained high at 7% of GDP in 2019, or lower by only 1 percentage points of GDP (YoY). Hydrocarbon revenue is estimated to have contracted by over 4% in 2019 (YoY). Non-oil revenue has seen some added momentum in 2019 and increased by 0.1 percentage points of GDP (YoY), largely due to the adoption of a new excise tax on selected products in mid-June. However, with hydrocarbon production accounting for over 30% of the income, more than 50% of exports, and 70% of government revenues, and given the projected lower oil prices, the fiscal deficit will remain elevated indicating the need for fundamental fiscal reforms, as per the World Bank. Low oil prices will create challenges to the implementation of supportive public spending for the country with already high deficits, more limited buffers and an elevated debt level. At such, the fiscal deficit is expected to markedly widen to over 17% of GDP in 2020, before starting to slightly narrow down over 2021-2022 assuming more favorable oil prices. The current account deficit is estimated to have slightly narrowed to 5% of GDP in 2019 driven by favorable trade balance and lower global imports price, with remittances having fallen with fewer expatriates. Reflecting the current account deficit, foreign reserves dropped to an estimated US$16.7 billion (or 6 months of imports), from US$17.4 billion in 2018 (or 6.3 months of imports), despite the recent bond issuance. The trend of fiscal and current account deficits, together

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with rising public debt will accelerate in a weaker oil price environment. As a result, the current account deficit is expected to deteriorate reaching over 15% of GDP this year, and to remain elevated to almost 10 percent of GDP in 2021-2022.

Current Account & Fiscal Balances as % of GDP Private Consumption Growth (%)

10 8.7 5

0 2014 2015 2016 2017 2018 2019e 2020f 2021f 2022f -5

-10 2.9 -15 2.5 1.9 1.7 -20 1 0.7 0.1 -25 Current Account Balance (% of GDP) Fiscal Balance (% of GDP) 2015 2016 2017 2018 2019e 2020f 2021f 2022f

Source: World Bank Economic Outlook, April 2020 (e = estimate, f = forecast)

CBO’s support measures against Covid-19 On 18 March 2020, the Central Bank of Oman (CBO) announced a comprehensive incentive package to inject additional liquidity of more than OMR 8 billion (USD 20.78 billion) into the economy. Key measures announced as part of the package include: • Lower capital conservation buffers by 50%, from 2.5% to 1.25% • Increase the lending ratio/financing ratio by 5%, from 87.5% to 92.5%, on the condition that this additional scope be reserved for lending to productive sectors of the economy, including the healthcare sector • Accept requests for deferment of loans/interest (profit for Islamic financial institutions) for affected borrowers, particularly SMEs, with immediate effect for the coming six months without adversely impacting the risk classification of such loans • Defer the risk classification of loans pertaining to government projects for a period of six months • Local banks to consider reducing existing fees for various banking services and avoid introducing new fees in 2020 • Reduce the interest rate on repo operations by 75 basis points, to 0.50%, and increase the tenor of repo operations up to a maximum of three months • Decrease interest rate on discounting of government treasury bills by 100 basis points, to 1.00% • Reduce the interest rate on foreign currency swap operations by 50 basis points and increase in the tenor of swap facility up to a maximum period of six months • Lower the interest rate on rediscounting of a bill of exchange and promissory note (with two signatures) by 100 basis points, to 3% • Decrease the interest rate on rediscounting of a promissory note with acceptable guarantee by 100 basis points, to 3.25% • Reduce the interest rate on rediscounting of a promissory note accompanied by trust receipt by 125 basis points, to 3.50%.

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Adequate CBO Forex Reserves CBO's foreign assets as at the end of Feb'20 stood at OMR 6.11bn, having contracted by 6%YoY and 3%MoM. CBO's foreign assets are below the trailing 12-month simple average of OMR 6.31bn. Even though reserves have fallen, the total amount, along with 2 sovereign wealth funds’ assets. is sufficient to support the USD-OMR peg.

CBO Fx Assets, OMR bn Oman's Monthly Fiscal Deficit / (Surplus), OMR mn 7.0 25% 1,000 6.8 20% 800 6.6 15% 600 6.4 10% 400 6.2 5% 200 6.0 0% - 5.8 -5% (200) 5.6 -10% 5.4 -15% Jul-19 Jan-19 Jun-19 Oct-19 Oct-18 Feb-19 Apr-19 Sep-19 Dec-19 Dec-18 Aug-19 Nov-19 Nov-18 Mar-19 May-19 Jul-19 Jan-20 Jun-19 Oct-19 Feb-20 Feb-19 Apr-19 Sep-19 Dec-19 Aug-19 Nov-19 Mar-19

May-19 Fiscal Deficit (OMR mn)

CBO Fx Assets (LHS) Avg (LHS) YoY (RHS) Linear (Fiscal Deficit (OMR mn))

Source: CBO

Deposit growth has picked up since the start of the year The total credit of the Omani Banking sector (conventional loans and Islamic financing) stood at OMR 25.9bn as at Feb- 20 end, with YoY pace of growth having slowed down to 2.5%YoY. Total credit growth was flat on month-on-month basis (+0.1%MoM). Total deposits stood at OMR 23.6bn, up by 4.0% YoY and flat on MoM basis.

Omani Banking Sector: Total Credit Credit & Deposit Growth (YoY)

26.0 8.0% 9.0% 25.8 7.0% 7.0% 6.0% 25.6 5.0% 25.4 5.0% 4.0% 25.2 3.0% 3.0% 25.0 2.0% 24.8 1.0% 1.0% Jul-19 Jul-19 Jan-20 Jun-19 Oct-19 Feb-19 Apr-19 Feb-20 Jan-20 Sep-19 Jun-19 Dec-19 Oct-19 Aug-19 Feb-19 Apr-19 Feb-20 Sep-19 Nov-19 Dec-19 Mar-19 Aug-19 Nov-19 May-19 Mar-19 May-19

Credit, OMR bn (LHS) YoY Growth, % (RHS) Credit Growth Deposit Growth

Source: CBO

Conventional banks account for 84.5% of total system credit at OMR 21.9bn as at the end of Feb’20, with growth rate having slowed down to 1.4%YoY. Conventional deposits at OMR 20.07bn (+2.5% YoY) form 85% of the total banking deposits of Oman. We believe that credit and deposit growth will remain muted for 2020, before improving in the coming years, based on World Bank’s GDP growth forecasts.

Government & Public Sector Deposits account for ~33% of total deposits; Deposit flight highly unlikely

Traditionally, Omani banks have had low reliance on wholesale markets. Government deposits have always been an important source of funding for the banks, as is characteristic of a resource dependent economy. However, the risk of withdrawal is not imminent as the government resorted to borrowing from international markets to finance its budget deficit. The government and public sector together comprise OMR 7.8bn or 33% of the total deposit base as at Feb’20 end, vs. 2-year average of 34%.

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Total Deposit Concentration, Feb'20 Total Credit Concentration, Feb'20 Govt Non 1% Public Non Residents Enterprise resident 2% 10% 1%

Govt 27%

Private Public Private Sector Enterprises Sector 65% 6% 88%

Source: CBO

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Valuation

We use a blended Excess Returns Methodology (80% weightage) and Peer-Group Price-to-Book’20e multiple based valuation (20% weightage) to arrive at our target price for each bank. We find present value of the excess returns (net profit minus the cost of equity) for each year over the forecast period (2020-2024e). This present value is then added to the equity value invested currently and the terminal value. For terminal value calculation, we use the relationship between an estimated long-term ROE and retention ratio as proxy for terminal growth rate for each entity. Valuation BKMB BKDB NBOB BKSB ABOB HBMO OMR mn OMR mn OMR mn OMR mn OMR mn OMR mn PV of Excess Returns & Terminal Value Year 1 (122) (55) (33) (18) (7) (18) Year 2 (107) (46) (29) (17) (6) (23) Year 3 (93) (39) (19) (14) (5) (19) Year 4 (80) (32) (15) (11) (3) (16) Year 5 (64) (30) (11) (9) (2) (12) Terminal (244) (46) (51) (70) (10) (70)

Assumptions Risk Free Rate 7.3% 7.3% 7.3% 7.3% 7.3% 7.3% Risk Premium (Market Risk, Company Risk, Country Risk) 8.2% 8.2% 8.2% 8.2% 8.2% 8.2% Beta 1.12 1.108 0.97 1.16 0.75 0.08 Cost of Equity (COE) in extraordinary growth period 16.5% 16.4% 15.3% 16.8% 13.4% 8.0% Terminal Growth Rate 3.6% 4.8% 3.6% 5.4% 3.9% 3.9% Fair Value of Equity 1,190 276 280 188 206 194 Outstanding Share (mn) 3,250 2,996 1,626 2,435 1,650 2,000

BVPS'20 0.597 0.179 0.261 0.143 0.168 0.180 Peer-group P/B'20 0.66 0.66 0.66 0.66 0.66 0.66

Fair Value

Fair Value (OMR) 0.370 0.097 0.172 0.080 0.126 0.101

Current Market Price (OMR) 0.324 0.104 0.157 0.082 0.120 0.094

Upside/(Downside) 14% -7% 10% -2% 5% 7%

Recommendation Accumulate Hold Hold Hold Hold Hold

Source: Company Financials, Bloomberg, U Capital Research Risks to Valuation

Key downside risks to our valuations include: • A slower-than-expected credit offtake. • Deterioration in asset quality and loan-loss coverage levels resulting in higher-than-expected cost of risk. • A faster resolution to the Covid-19 pandemic, resulting in a better-than-expected GDP growth. Key upside risks to our valuation include: • Better-than-expected sovereign risk profile resulting in a lower cost of equity. • Better-than-expected credit offtake. • More prolonged pandemic, resulting in negative revision in the country’s GDP growth outlook

Page 16 of 38

Peer Group Multiples

Name Mkt Cap Last Px Px Change P/B'20e, P/E'20e, ROE'20e, Div Yield'20e, (OMR mn) (OMR) (1M), % (x) (x) % % SAUDI BRITISH BANK 4,507.8 2.194 -7% 0.76 12.5 6% 4.9% RIYAD BANK 4,976.0 1.659 -1% 1.14 9.7 13% 5.6% ABU DHABI COMMERCIAL BANK 3,004.4 0.432 8% 0.56 13.6 6% 4.9% BANQUE SAUDI FRANSI 3,571.0 2.963 5% 1.04 13.7 7% 4.9% ARAB NATIONAL BANK 2,804.8 1.870 -7% 0.94 9.8 11% 5.2% MASRAF AL RAYAN 2,990.8 0.399 1% 1.92 13.6 16% 5.5% COMMERCIAL BANK PQSC 1,679.0 0.415 -1% 0.84 8.4 12% 5.3% BOUBYAN BANK K.S.C 1,825.9 0.603 -2% 2.13 18.8 11% 2.0% BANK ALBILAD 1,616.1 2.155 -4% 12.0 15% BANKMUSCAT SAOG 1,052.8 0.324 6% 0.54 6.1 9% 9.3% SAUDI INVESTMENT BANK/THE 998.0 1.331 -2% 9% GULF BANK 787.2 0.272 8% 0.89 9.9 9% 4.8% DOHA BANK QPSC 651.6 0.210 2% 0.65 11.4 5.5% BURGAN BANK 675.4 0.258 4% 0.72 8.5 9% 3.4% BANK DHOFAR SAOG 311.6 0.104 16% 0.58 11.6 5% 2.9% NATIONAL BANK OF OMAN SAOG 255.3 0.157 1% 0.60 6.5 9% 6.4% BANK SOHAR 199.6 0.082 -2% 0.57 6.7 9% 7.3% HSBC BANK OMAN 188.0 0.094 -10% 0.52 8.7 6% 6.8% AHLI BANK 198.0 0.120 -8% 0.72 7.0 10% 8.3% Average 0.88 11.7 10% 5.5% Median 0.74 10.7 9% 5.3%

Source: Bloomberg, U Capital Research

Price to Book & Return on Equity

11.0% Ahli Bank

10.0% Bank Muscat NBO 9.0% Bank Sohar

8.0%

7.0%

HSBC Oman Return on Equity '20e on Equity Return 6.0%

Bank Dhofar 5.0%

4.0% 0.50 0.55 0.60 0.65 0.70 0.75 Price to Book (x) '20e

Page 17 of 38

Sensitivity Analysis

Our valuations are sensitive to cost of equity and cost of risk (as a % if Interest-earning Assets (IEAs)), as presented below:

BKMB Base Case: Cost of risk for 2020e at 75bps, with Cost of Risk, bps roughly 10bps annual easing out beyond 2020e: 0.370 35 55 75 95 115 Cost of equity: 16.5%, TP: OMR 0.370 per share. 14.5% 0.420 0.410 0.400 0.390 0.380 15.5% 0.410 0.390 0.380 0.370 0.360 With every +/-20bps change in cost of risk, BKMB’s 16.5% 0.390 0.380 0.370 0.360 0.350 TP moves (+/-) 2.8%. 17.5% 0.380 0.370 0.360 0.350 0.340 Cost Equity of 18.5% 0.370 0.360 0.350 0.340 0.330 With every +/- 1% change in cost of equity, TP moves (+/-) 2.8%. However, when cost of equity is 14.5%, with cost of risk at 75bps, TP goes up by 5.3%. BKDB Base Case: Cost of risk for 2020e at 73bps, with Cost of Risk, bps roughly 10bps annual easing out beyond 2020e: 0.097 53 63 73 83 93 Cost of equity: 16.4%, TP: OMR 0.097 per share. 14.4% 0.111 0.109 0.106 0.104 0.101 15.4% 0.106 0.104 0.101 0.100 0.097 We found BKDB’s TP to be more sensitive to 16.4% 0.102 0.100 0.097 0.095 0.093 changes in cost of risk. With every +/-10bps 17.4% 0.098 0.096 0.093 0.092 0.089 change in cost of risk, TP moves (+/-) about 2%. Cost Equity of 18.4% 0.094 0.092 0.089 0.088 0.085 With every +/- 1% change in cost of equity, TP moves (+/-) about 4%. NBOB Base Case: Cost of risk for 2020e at 60bps, with Cost of Risk, bps roughly 10bps annual easing out beyond 2020e: 0.172 20 40 60 80 100 Cost of equity: 15.3%, TP: OMR 0.176 per share. 13.3% 0.203 0.194 0.185 0.176 0.167 14.3% 0.196 0.187 0.178 0.170 0.161 We found NBOB’s TP to be more sensitive to 15.3% 0.189 0.181 0.172 0.164 0.156 changes in cost of risk. With every +/-20bps 16.3% 0.182 0.174 0.167 0.159 0.151 change in cost of risk, TP moves (+/-) about 5%.

Cost Equity of 17.3% 0.176 0.169 0.161 0.153 0.145 With every +/- 1% change in cost of equity, TP moves (+/-) 3%-4%. BKSB Base Case: Cost of risk for 2020e at 75bps, with Cost of Risk, bps roughly 10bps annual easing out beyond 2020e: 0.080 35 55 75 95 115 Cost of equity: 16.8%, TP: OMR 0.078 per share.

14.8% 0.097 0.092 0.087 0.082 0.077 We found BKSB’s TP to be more sensitive to 15.8% 0.093 0.088 0.083 0.079 0.073 changes in cost of risk. With every +/-20bps 16.8% 0.090 0.086 0.080 0.076 0.072 change in cost of risk, TP moves (+/-) about 5%. 17.8% 0.088 0.083 0.079 0.075 0.070 However, with the first 20bps reduction in cost of

Cost Equity of 18.8% 0.087 0.082 0.078 0.074 0.069 risk, TP increases by 7.5%.

BKSB’s TP is more sensitive to declines in cost of equity than increases in the same. With every +1% change in cost of equity, TP moves down only by

Page 18 of 38

1%. However, with every 1% decline in cost of equity, TP moves up by about 4% to 5%. ABOB Base Case: Cost of risk for 2020e at 50bps, with Cost of Risk, bps roughly 5bps annual easing out beyond 2020e: 0.126 10 30 50 70 90 Cost of equity: 13.5%, TP: OMR 0.126 per share. 11.4% 0.183 0.174 0.166 0.158 0.150 12.4% 0.151 0.150 0.142 0.134 0.126 We found ABOB’s TP to be more sensitive to the 13.4% 0.135 0.126 0.126 0.118 0.110 first negative change in cost of risk of 10bps. Our 14.4% 0.119 0.110 0.110 0.102 0.102 TP is insensitive to cost of risk declines. Cost Equity of 15.4% 0.103 0.102 0.094 0.094 0.086 ABOB’s TP is more sensitive to changes in cost of equity. With every (+/-) 0.5% change in cost of equity, TP moves (+/-) 6%. HBMO Base Case: Cost of risk for 2020e at 60bps, with Cost of Risk, bps roughly 10bps annual easing out beyond 2020e: 0.101 20 40 60 80 100 Cost of equity: 13.8%, TP: OMR 0.106 per share. 12.8% 0.122 0.118 0.115 0.112 0.108 13.3% 0.114 0.111 0.108 0.105 0.101 We found HBMO’s TP to be more sensitive to the 13.8% 0.107 0.105 0.101 0.098 0.095 first positive change in cost of risk of 20bps (TP 14.3% 0.102 0.098 0.096 0.093 0.089 goes up by about 4%). Our TP declines by about 3% Cost Equity of 14.8% 0.096 0.094 0.090 0.088 0.084 with each 20bps cost of risk increase.

HBMO’s TP is more sensitive to changes in cost of equity. With every (-) 0.5% change in cost of equity, TP moves up by about 7%. With every (+) 0.5% change in cost of equity, its TP declines by about 5%-6%.

Source: U Capital Research

Page 19 of 38

Bank Muscat SAOG

TP: OMR 0.370/share Bank Muscat SAOG Upside: 14% Recommendation Accumulate • Largest Bank in Oman with a market share of about 43% in terms of assets as of FY19 Bloomberg Ticker BKMB OM • Solid Capital Position, CAR of 19.81% as at the end of FY19 Current Market Price (OMR) 0.324 • Net profit likely to contract in 2020 before growing at a CAGR of 9% between 2021- 52wk High / Low (OMR) 0.450/0.300 2024e 12m Average Vol. (000) 882.3 • Credit quality metrics to remain under pressure due to the ongoing crisis Mkt. Cap. (USD/OMR mn) 2,737/1,053 Shares Outstanding (mn) 3,249.5 We downgrade our rating on Bank Muscat to Accumulate with a target price of OMR Free Float (%) 76% 0.370 per share, implying an upside of ~14% to the last closing price. Our target price 3m Avg Daily Turnover (OMR'000) 465.1 implies a P/E’20e of 6.2x, and P/B’20e of 0.62x. We believe that this fair value is 6m Avg Daily Turnover (OMR'000) 476.9 justified at this time given that liquidity pressures will likely negatively affect net P/E'20e (x) 6.1 interest margins along with a rise in cost of risk resulting in slower net profit growth P/B'20e (x) 0.5 outlook for the bank. We expect the bank to post a reasonable loan-book growth (at Cash Dividend Yield '20e (%) 9.3% an 6% CAGR over 2020-2024e) as macroeconomic situation improves over the Price Performance: forecast period and real GDP growth bounces back to positive territory post-2020. We 1 month (%) 5.88 expect the bank’s capital ratios to remain firm and above some of the regional peers, 3 month (%) (24.40) even though there will be an upward pressure on NPLs in the short to medium term. 12 month (%) (15.79) Furthermore, we expect the bank to reduce cash dividend for FY20 to OMR 0.030 per share on an expected drop in annual net profit for the year. Source: Bloomberg Valuation & Risks Our target price is based on a weighted average of Excess Returns Methodology & Peer-Group P/B multiple for 2020e. The steep rise in cost of equity has resulted in a Price-Volume Performance contraction in the target price of the stock. We have used a discount rate of 16.5% and a terminal growth rate of 4.6% based on 40% retention ratio. Key downside risks 0.450 6,000 to our valuation include slower-than-expected credit offtake, asset quality 0.430 5,000 deterioration and any reduction in loan-loss-coverage levels. Key upside risks to our 0.410 valuation include better-than-expected loan growth resulting in higher interest 4,000 0.390 income, and improvements in asset quality and loan-loss coverage levels rather than 0.370 3,000 the expected deterioration.

0.350 2,000 Performance for 1Q20 0.330 1,000 The bank has posted a net profit for 1Q20 that is down by 27.4%YoY and 24.6%QoQ 0.310 on a 91.2%YoY rise in net ECL charge for the quarter as compared to a year ago. Net 0.290 - ECL charge is higher by 43%QoQ, likely due to changes in ECL of some exposures on the current covid-19 pandemic and low oil prices. The bank's net interest income for Jul-19 Jan-20 Jun-19 Oct-19 Apr-20 Sep-19 Feb-20 Dec-19 Aug-19 Nov-19 Mar-20 May-19 1Q20 grew by 3.1%YoY and 2.8%QoQ, in line with our estimate. Other operating Vol, '000 (RHS) Px, OMR (LHS) income, however, disappointed by falling 8.4%YoY and 17%QoQ, landing 9.4% below

Source: Bloomberg our estimate, likely on a slower credit offtake. Total operating income was roughly in line with our estimate. The bank has posted a 1.2%YoY decline and a 1.9%QoQ increase in its net loans & Islamic financing portfolio. Its customer deposits increased by 2.0%YoY and 1.9%QoQ.

Income Statement (OMR mn) 1Q19 4Q19 1Q20 YoY (%) QoQ (%)

Net Interest & Islamic Finance Income 78.8 79.0 81.2 3.1% 2.8% Other operating income 37.6 41.4 34.4 -8.4% -17.0% Operating Income 116.3 120.4 115.6 -0.6% -4.0% Operating expenses (48.6) (51.4) (50.6) 4.2% -1.5% Ayisha Zia Operating Profit 67.7 69.0 65.0 -4.0% -5.8% Research Analyst Net ECL charge / net impairment (13.5) (18.0) (25.7) 91.2% 43.0% [email protected] Tax (8.5) (6.9) (6.0) -28.8% -12.8% Tel: +968 24 94 90 36 Net Profit 45.8 44.1 33.3 -27.4% -24.6% Source: Company Financials, U Capital Research

Page 20 of 38

Bank Muscat SAOG

Topline performance to remain strong; net ECL charges to weigh on net profit BKMB’s net profit is expected to fall by about 6.7% in 2020 primarily on higher net ECL charges due to the ongoing Covid-19 crisis and depressed oil & gas revenues of the country. We expect some pressure to build on the bank’s NIMs as liquidity tightens with sustained low oil prices (BKMB sports a CASA mix of 66% of total deposits, supporting its NIMs outlook). However, as we have factored in a loan-book growth pick-up from 2021e onwards as per the World Bank real GDP growth forecasts, we believe that net profit should be able to grow at a CAGR of about 9% over 2021-2024e. Nonetheless, rising cost of risk should continue to weigh on profitability.

BKMB: Net Interest Margin BKMB: Asset Quality Metrics

3.00% 3.4% 1.4 2.95% 3.3% 1.2 2.90% 3.2% 1.0 3.1% 2.85% 0.8 3.0% 2.80% 0.6 2.9% 2.75% 2.8% 0.4 2.70% 2.7% 0.2 2.65% 2.6% - FY16 FY17 FY18 FY19 FY20e FY21e FY16 FY17 FY18 FY19 FY20e FY21e NPL Coverage, x (RHS) NPLs to Gross Loans & Islamic Financing, x (LHS) Source: Company Financials, U Capital Research Tepid loan growth outlook for 2020; Growth to pick up from 2021 onwards We expect a tepid 1.1% loan growth in 2020 vs. 0.7% contraction in 2019, on a 3.5% contraction in real GDP output expected by the World Bank. Even though we expect corporates’ financing needs to go up due to Covid-19, we expect the bank to remain cautious in extending credit in the current macroeconomic scenario. Furthermore, low state oil & gas revenue is likely to affect government projects and retail lending will remain under pressure due to Covid 19. However, as real GDP growth picks up from 2021 onwards, we expect loan-book growth to normalize to a certain extent. BKMB: Loan & Deposit Growth BKMB: Capital Adequacy Ratios 20.0% 22.0% 19.8% 15.0% 19.4% 20.0% 19.0% 18.6% 18.1% 10.0% 18.0% 16.9% 17.1% 5.0% 16.0% 14.7% 0.0% 14.0% -5.0% 12.0% -10.0%

10.0% 4Q18 1Q19 2Q19 3Q19 4Q19 Q1'17 Q2'17 Q3'17 Q4'17 Q1'18 Q2'18 Q3'18 Net loan & Islamic financing growth (YoY) FY16 FY17 FY18 FY19 Tier 1 Capital Ratio Tota Capital Adequacy Ratio (CAR) Conventional & Islamic Deposit Growth (YoY) Source: Company Financials, U Capital Research Robust capitalization levels ensure ability to weather the current downturn BKMB boasts the highest level of capitalization amongst its local peers with the total capital adequacy ratio at 19.8% as at the end of FY19. The bank’s capital adequacy ratio is comfortably above CBO-mandated minima, including Capital Conservation Buffer and Countercyclical Buffer requirements.

Page 21 of 38

Bank Muscat SAOG

Key Financials (OMR mn) FY17 FY18 FY19 FY20e FY21e FY22e Income Statement Interest/Financing Income 424.4 478.6 518.1 523.4 538.8 567.5 Interest Expense/Payment to Depositors (143.0) (174.4) (201.1) (201.5) (208.5) (218.4) Net Interest/Financing Income 281.3 304.3 317.0 321.9 330.4 349.1 Fee & Commission Income 93.1 96.5 102.3 105.4 109.5 115.7 Other Income 61.6 46.0 52.9 54.5 56.7 59.8 Total Non-Interest/Financing Income 154.6 142.4 155.2 159.9 166.2 175.5

Total Operating Income 436.0 446.7 472.2 481.8 496.6 524.6 Operating Expenses (184.1) (190.3) (195.9) (199.5) (205.3) (216.6) Operating Profit 251.9 256.4 276.2 282.4 291.2 308.0 Provisions expense (40.8) (43.2) (56.1) (76.4) (74.7) (77.3) Profit Before Taxation 211.0 213.2 220.1 206.0 216.6 230.7 Taxation & others (34.2) (33.5) (34.6) (32.3) (34.0) (36.2) Net Profit Attributable to Parent 176.8 179.6 185.6 173.7 182.5 194.5 Interest of Tier 1 Perpetual Securities (3.6) (7.2) (7.2) (7.2) (7.2) (7.2) Net Profit Attributable to shareholders 173.2 172.5 178.4 166.5 175.4 187.3 Balance Sheet Cash Balances 935 1,307 782 625 576 388 Deposits with Banks & FIs 592 476 870 952 1,058 1,140 Net Loans & Islamic financing 8,329 8,939 8,878 8,980 9,429 9,995 Investments 1,027 1,270 1,445 1,582 1,758 1,894 Net Fixed Assets 72 70 79 74 74 76 Other Assets 194 227 237 259 288 310 Total Assets 11,149 12,288 12,291 12,472 13,183 13,803

Deposits from Banks & FIs 910 952 1,173 1,193 1,267 1,331 Total Customer Deposits 7,419 8,463 8,044 8,174 8,687 9,120 Other Borrowings 583 469 502 457 458 460 Other Liabilities 419 477 569 578 615 645 Total liabilities 9,331 10,360 10,288 10,402 11,027 11,556

Paid-up Capital 271 295 309 325 341 358 Retained Earnings 421 485 526 546 583 626 Other Reserves 997 1,018 1,037 1,070 1,101 1,134 Shareholders' Equity 1,688 1,798 1,873 1,940 2,026 2,118 Minority Interest, Tier 1 Perpetual Notes 130 130 130 130 130 130 Total Equity & Liabilities 11,149 12,288 12,291 12,472 13,183 13,803 Cash Flow Statement Cash from operations (220) 554 (437) (11) 47 (86) Cash from investing activities (50) (3) 10 (6) 1 2 Cash from financing 63 (185) (78) (151) (96) (101) Net changes in cash (107) 372 (525) (156) (49) (188) Cash at the end of period 935 1,307 782 625 576 388 Key Ratios Return on Average Assets 1.6% 1.5% 1.5% 1.4% 1.4% 1.4% Return on Average Equity 10.9% 10.3% 10.1% 9.1% 9.2% 9.4% Net Interest Income & Islamic Finance Income/ Operating Income 64.5% 68.1% 67.1% 66.8% 66.5% 66.5% Other Operating Income/Operating Income 35.5% 31.9% 32.9% 33.2% 33.5% 33.5% Net fee income/Operating Income 21.3% 21.6% 21.7% 21.9% 22.1% 22.0% Interest Earning/Finance Asset Yield 4.4% 4.6% 4.7% 4.6% 4.5% 4.5% Cost of Funds 1.6% 1.9% 2.1% 2.1% 2.1% 2.1% Net Spread 2.7% 2.8% 2.7% 2.5% 2.5% 2.4% Cost to Income Ratio 42.2% 42.6% 41.5% 41.4% 41.3% 41.3% Net Loans to Customer Deposits 112.3% 105.6% 110.4% 118.9% 124.3% 127.6% Net Loans & Islamic Financing to Customer Deposits (Total LTD) 112% 106% 110% 119% 124% 128% Non Performing Loans, OMR mn 254 287 299 307 327 352 NPLs to Gross Loans & Islamic Financing, % 2.9% 3.1% 3.2% 3.3% 3.3% 3.4% NPL Coverage, % 128.9% 114.8% 105.5% 103.9% 102.3% 100.8% Cost of Risk (bps) 21.7 48.9 60.8 82.6 78.4 76.8 Shareholders'Equity to Total Loans & Islamic Financing, x 0.20 0.19 0.20 0.21 0.21 0.20 Shareholders' Equity to Total Assets, x 0.15 0.15 0.15 0.16 0.15 0.15 Capital Adequacy Ratio, % 18.6% 19.4% 19.8% 19.1% 18.7% 18.4% EPS (OMR) 0.065 0.061 0.060 0.053 0.054 0.054 BVPS (OMR) 0.623 0.610 0.605 0.597 0.594 0.591 Market Price (OMR) * 0.375 0.410 0.434 0.324 0.324 0.324 Cash Dividend Payout Ratio, % 46.0% 57.4% 58.4% 56.1% 56.1% 55.3% Cash Dividend Yield, % 8.0% 8.5% 8.1% 9.3% 9.3% 9.3% P/E Ratio (x) 5.7 6.7 7.2 6.1 6.1 6.0 P/BV Ratio (x) 0.6 0.7 0.7 0.5 0.5 0.5 *Market price for current year and subsequent years as per the closing price on 05-May-2020 Source: Company Financials, U Capital Research

Page 22 of 38

Bank Dhofar SAOG

TP: OMR 0.097/ share Bank Dhofar SAOG Upside/ (Downside): (7%)

• Has shored up capital through multiple rights issues and Tier 1 issuances over the last Recommendation HOLD few years; total CAR at 17.86%, above the minimum prescribed by the Central Bank of Bloomberg Ticker BKDB OM Oman Current Market Price (OMR) 0.104 • Operational performance has weakened: mediocre NIMs, high cost-to-income ratio 52wk High / Low (OMR) 0.150/0.090 within the sector, cost of risk also high 12m Average Vol. (000) 300.2 • Tier 1 Perpetual notes’ call option foregone by BKDB on current market conditions; has Mkt. Cap. (USD/OMR Mn) 810/312 option to call at semi-annual intervals from now Shares Outstanding (mn) 2,996.4 Free Float (%) 66% We maintain our HOLD rating for BKDB with a reduced target price of OMR 0.098 3m Avg Daily Turnover (OMR'000) 42.5 6m Avg Daily Turnover (OMR'000) 32.1 per share. Our target price implies a P/e’20e of 10.8x, and a P/b’20e of 0.54x. We P/E '20e (x) 11.6 believe that this fair value is justified because of operational performance under P/B '20e (x) 0.58 pressure: (1) low NIMs (2) high cost-to-income ratio (3) inflated cost of risk. Dividend Yield '20e(%) 2.9% Additionally, Q1’20 performance has been mediocre forcing us to revise our forecasts. Price Performance: Valuation & Outlook 1 month (%) 15.56 3 month (%) (8.77) BKDB’s NIM has deteriorated consistently over the last few years due to rising 12 month (%) (25.18) funding costs given its low CASA mix at 41.8% vs. local peer-group avg. of 52.8%, in Source: Bloomberg addition to loan book contraction since 2018, as it has deliberately reduced its retail

loan exposure to comply with Central Bank requirements. The bank’s ROE has contracted to 3.6% in 2019 from 8.4% in 2018. Further margin erosion, lackluster fee Price-Volume Performance income and rising provisioning are expected to weigh down profitability in the near to medium term. Cost of equity for the bank, like its peers, has gone materially up, 0.160 4,000 resulting in a depressed valuation at OMR 0.100 per share. We expect dividend 0.150 3,500 distribution for 2020 to remain at OMR 0.003 per share. Operating income growth 0.140 3,000 over 2020-2024e is expected to be modest, growing at a CAGR of 5%, as loan book 0.130 growth picks up but spreads weigh down income. Operating expenses are expected 2,500 0.120 to grow more slowly than operating income. Cost risk is expected to rise in 2020 and 0.110 2,000 2021, after which we have assumed contraction in the cost, resulting in a net profit 0.100 1,500 growth of (CAGR of) 5.6% over 2020-2022e. 0.090 1,000 Key Risks 0.080 Key downside risk is slower than expected improvement in yields amid slow loan 500 0.070 growth whereas the opposite, if true, offers an upside risk together with any further 0.060 - efficiency improvements.

Jul-19 Jan-20 Jun-19 Oct-19 Apr-20

Sep-19 Feb-20 Operating Performance, 1Q20 Dec-19 Aug-19 Nov-19 Mar-20 May-19 The bank's 1Q20 net profit almost doubled from 4Q19. However, it is 30.2%YoY Vol, '000 (RHS) Px, OMR (LHS) below that of 1Q19. Operating income continues to be under pressure, declining by 9.5%YoY and flat QoQ. Operating expenses rose 7.2%QoQ. Net ECL charge has Source: Bloomberg declined by 64%QoQ, resulting in a doubling of net profit from the previous quarter.

Income Statement (OMR mn) 1Q19 4Q19 1Q20 YoY (%) QoQ (%) Operating Income 34.3 31.4 31.1 -9.5% -0.9% (17.0) (19.7) (18.6) 9.0% -5.8% Operating expenses Operating Profit 17.3 11.7 12.5 -27.7% 7.2% Net ECL charge (2.5) (6.0) (2.2) -12.7% -64.0% PBT 14.8 5.7 10.3 -30.2% 82.9% Ayisha Zia Tax (2.2) (1.3) (1.5) -29.7% 16.1% Research Analyst 12.6 4.3 8.8 -30.2% 103.4% Net Profit [email protected] Source: Company Financials, U Capital Research Tel: +968 24 94 90 36

Page 23 of 38

Bank Dhofar SAOG

Operating income under pressure due to a weak NIM & loan-book contraction BKDB’s operating income is under pressure due to weak NIM (one of the lowest amongst the peer-group). Furthermore, as the bank shed some loans, its net interest income has also declined in 2019. We expect NIMs to remain under pressure until 2022e, beyond which we have forecasted some recovery. BKDB: Net Interest Margin (NIM) BKDB: Operating Income Components 120 3.5% 9.00% 100 2.9% 8.00% 3.0% 7.00% 2.6% mnOMR 80 2.5% 2.5% 6.00% 2.5% 2.4% 5.00% 60 4.00% 2.0% 40 3.00% 1.5% 2.00% 20 1.00% 1.0% 0.00% - FY-16 FY-17 FY-18 FY-19 FY-20e FY-15 FY-16 FY-17 FY-18 FY-19 NIM Gross Yield Funding cost Total Net Interest Income Other income

Source: Company Financials, U Capital Research

The bank’s other operating income rose 2%YoY in 2019, but we expect it to remain under pressure going forward, especially for 2020e due to slow net loan growth and the CBO’s guidance to banks to not introduce any new fees as well as revise existing structure.

Capital raising activities have deteriorated profitability metrics In its drive to boost capital, the bank completed multiple rights issues and also raised AT1 capital. This has not augured well for the profitability metrics of the bank, which had already been deteriorating because of declining net profit growth. We believe that as the bank works towards strengthening its capital position, profitability improvement chances appear slim in lieu of the already challenging operating environment, and hence the bank’s current valuation is stretched, we believe.

BKDB: Profitability Metrics BKDB: Efficiency metrics 60.0% 1.7% 1.7% 10.0% 1.20% 55.0% 9.0% 1.7% 8.0% 1.00% 50.0% 1.6% 1.6% 7.0% 0.80% 45.0% 6.0% 1.6% 5.0% 0.60% 40.0% 1.5% 1.5% 1.5% 4.0% 35.0% 0.40% 3.0% 1.5% 30.0% 1.4% 2.0% 0.20% 1.0% 25.0% 1.4% 0.0% 0.00% 20.0% 1.4% FY16 FY17 FY18 FY19 FY16 FY17 FY18 FY19 FY20e RoAE (after Interest on Tier 1 Perpetual Notes) Cost / Operating Income Cost to Average Total Assets RoAA (after Interest on Tier 1 Perpetual Notes) Source: Company Financials, U Capital Research

Bank Dhofar’s current Tier 1 capital adequacy at 16.4% is reasonable as compared to peers, and is well above the regulatory minimum mandated by the Central Bank of Oman. The bank’s total capital adequacy stood at 17.9% as at the end of FY19. Cost efficiency likely to improve during the forecast period BKDB has been revamping its IT systems in line with bank strategy, leading to escalation of it cost-to-income ratio reaching record high of 55% in 2019 vs. 50% in 2018. We expect this ratio to remain above 50% for the first three years after which we expect the ratio to normalize to prior levels on income growth.

Page 24 of 38

Bank Dhofar SAOG

Key Financials (OMR mn) FY17 FY18 FY19 FY20e FY21e FY22e Income Statement Interest/Financing Income 196.3 194.1 197.2 202.8 212.2 229.6 Interest Expense/Payment to Depositors (96.6) (99.3) (102.1) (106.4) (115.2) (124.6) Net Interest/Financing Income 99.7 94.8 95.1 96.3 96.9 105.0 Fee & Commission Income 15.6 14.2 14.0 14.7 15.7 17.0 Other Income 18.8 20.9 18.0 18.9 20.1 21.8 Total Non-Interest/Financing Income 34.4 35.1 31.9 33.5 35.8 38.8

Total Operating Income 134.1 130.0 127.0 129.9 132.8 143.7 Operating Expenses (6.7) (22.4) (29.2) (27.7) (26.5) (25.2) Operating Profit (67.7) (71.5) (66.1) (67.7) (69.7) (75.7) Provisions expense 59.7 36.1 31.8 34.5 36.6 42.7 Profit Before Taxation (9.5) (5.8) (5.0) (5.5) (5.8) (6.8) Taxation & others (9.5) (5.8) (5.0) (5.5) (5.8) (6.8) Net Profit 47.6 50.3 30.2 26.8 29.0 30.8 Interest on Tier 1 Perpetual Securities (7.9) (10.9) (10.9) (10.9) (10.9) (10.9) Net Profit Attributable to shareholders 39.7 39.4 19.3 15.9 18.1 19.9 Balance Sheet Cash Balances 327 302 300 137 157 110 Deposits with Banks & FIs 300 329 471 485 509 545 Net Loans & Islamic financing 3,249 3,159 3,063 3,196 3,393 3,661 Investments 331 304 379 390 409 438 Net Fixed Assets 10 15 19 12 14 13 Other Assets 71 105 93 96 101 108 Total Assets 4,287 4,213 4,326 4,315 4,583 4,874

Deposits from Banks & FIs 388 369 490 376 403 433 Total Customer Deposits 3,068 2,925 2,943 3,036 3,256 3,496 Other Borrowings 89 64 64 64 64 64 Other Liabilities 115 158 142 147 158 169 Total liabilities 3,660 3,515 3,640 3,622 3,881 4,161

Paid-up Capital 226 280 300 300 300 300 Retained Earnings 55 59 10 16 23 32 Other Reserves 190 203 221 222 224 226 Shareholders' Equity 472 543 531 538 547 558 Tier 1 Perpetual Notes 156 156 156 156 156 156 Total Equity & Liabilities 4,287 4,213 4,326 4,315 4,583 4,874 Cash Flow Statement Cash from operations 47 (50) 109 (151) 50 (10) Cash from investing activities 77 (21) 78 4 21 28 Cash from financing 91 4 (31) (9) (9) (9) Net changes in cash 61 (25) (1) (164) 21 (47) Cash at the end of period 327 302 300 137 157 110 Key Ratios Return on Average Assets 1.2% 1.2% 0.7% 0.6% 0.7% 0.7% Return on Average Equity 10.7% 9.9% 5.6% 5.0% 5.4% 5.6% Net Interest & Islamic Finance Income / Operating Income 73.4% 74.3% 73.0% 74.9% 74.2% 73.0% Other operating income / Operating Income 26.6% 25.7% 27.0% 25.1% 25.8% 27.0% Net fee Income/Operating Income 13.6% 11.6% 10.9% 11.0% 11.3% 11.8% Interest Earning/Financing Assets Yield 4.83% 5.12% 5.04% 4.94% 4.84% 4.74% Cost of Funds -2.33% -2.65% -2.90% -2.93% -2.96% -2.99% Net Spread 2.51% 2.46% 2.14% 2.01% 1.88% 1.75% Cost to Income Ratio 46.5% 50.5% 55.0% 52.0% 52.1% 52.5% Net Loans & Islamic Financing to Customer Deposits (Total LTD) 105.9% 108.0% 104.1% 105.3% 104.2% 104.7% Non Performing Loans, OMR mn 106 121 151 134 141 151 NPLs to Gross Loans & Islamic financing 3.1% 3.7% 4.7% 4.0% 4.0% 4.0% NPL Coverage, % 130.8% 111.4% 78.3% 82.7% 82.9% 83.0% Cost of Risk, bps 31.9 17.3 58.1 73.1 66.1 59.1 Shareholders' Equity to Total Loans & Islamic Financing, x 0.14 0.16 0.17 0.16 0.16 0.15 Shareholders' Equity to Total Assets, x 0.13 0.15 0.15 0.15 0.14 0.13 Capital Adequacy Ratio, % 15.4% 17.3% 17.9% 21.7% 20.9% 19.8% EPS, OMR 0.021 0.018 0.010 0.009 0.010 0.010 BVPS, OMR 0.209 0.194 0.177 0.179 0.182 0.186 Market Price, OMR* 0.222 0.166 0.123 0.104 0.104 0.104 Cash Dividend Payout Ratio, % 56.9% 55.7% 29.7% 33.5% 31.0% 29.2% Cash Dividend Yield, % 5.4% 6.0% 2.4% 2.9% 2.9% 2.9% P/E Ratio, x 10.5 9.2 12.2 11.6 10.7 10.1 P/BV Ratio , x 1.1 0.9 0.7 0.6 0.6 0.6 *Market price for current year and subsequent years as per the closing price on 05-May-2020 Source: Company Financials, U Capital Research

Page 25 of 38

National Bank of Oman SAOG

TP: OMR 0.172/ share National Bank of Oman SAOG Upside: 9.6%

Recommendation Hold • Superior ROE at 12% vs sector average of 9.9% Bloomberg Ticker NBOB OM • Lowest capital adequacy within locally listed peer-group at 16.7% vs. sector average of Current Market Price (OMR) 0.157 18.1% 52wk High / Low (OMR) 0.210/0.150 • Weakened asset quality; highest NPL ratio within local peer-group 12m Average Vol. (000) 366.8 We downgrade National Bank of Oman (NBOB) to HOLD from our earlier rating of Mkt. Cap. (USD/OMR Mn) 664/255 Shares Outstanding (mn) 1,625.9 Accumulate, with a lower target price of OMR 0.172 per share, which implies a Free Float (%) 27% P/e’20e of 7.1x and P/b’20e of 0.66x. We believe that this fair value is justified 3m Avg Daily Turnover (OMR'000) 83.0 because of hampered loan growth outlook, deteriorating asset quality and low net 6m Avg Daily Turnover (OMR'000) 73.3 profit growth visibility.

P/e 2020e (x) 6.5 Valuation & Outlook P/b 2020e (x) 0.60 Cash Dividend Yield '20e (%) 6.4% We have arrived at our TP through Excess Returns Methodology and peer-group average P/B’20 multiple. We expect the bank to have a muted loan-book growth in Price Performance: 2020 as macroeconomic situation remains subdued. However, over the rest of the 1 month (%) 1.29 forecast period, we have assumed a net loan CAGR of 8%. We expect NBO to continue 3 month (%) (22.28) to lower its retail exposure, which is currently highest within the sector at 47% of 12 month (%) (2.48) loans in 2019 (2017: 49%; 2018: 48%; regulatory cap: 50%). NBO has been reducing Source: Bloomberg its retail lending due to weak profitability. There is a regulatory ceiling on retail lending rate at 6%. We expect this trend to continue as asset quality issues are bound to arise owing to risks of layoffs and salary reductions under the current macroeconomic Price-Volume Performance scenario.

0.210 3,500 The bank’s NIMs are above sector average, and we expect the bank to be able to grow its net interest income over the forecast period. Cost of risk is expected to increase 0.200 3,000 due to the current scenario. Cost of equity for the bank, like its peers, has gone 0.190 2,500 materially up, resulting in a depressed valuation. We expect dividend distribution for 0.180 2,000 2020 to remain at OMR 0.0168 per share, coming only under pressure if cost of risk 0.170 1,500 rises more than expected resulting in a significant net profit fall. Key upside risks to 0.160 1,000 our rating include: i) stronger-than-expected loan growth; and ii) lower-than- 0.150 expected provisioning costs. 500 0.140 Loan growth and revenue growth stalled in 2019 0.130 - NBOB’s 2019 operating performance was modest, with net profit growing by

Jul-19 1.6%YoY. Even though net interest income grew 1.8%YoY, other operating income Jan-20 Jun-19 Oct-19 Apr-20 Sep-19 Feb-20 Dec-19 Aug-19 Nov-19 Mar-20 May-19 decline of 6.3%YoY weighed on the operating income. Operating expenses grew by Vol, '000 (RHS) Px, OMR (LHS) 3.1%YoY, resulting in an operating profit decline of 3.8%YoY. Impairment expense Source: Bloomberg grew by 4.7%YoY and a tax decline of 40%YoY resulted in support to net profit growth. Net loans & Islamic financing remained flat YoY as the bank remained conservative in loan book growth. Customer deposits, on the other hand, grew by 3.2%, providing some decline in loan-to-deposit ratio. Key Indicators Year FY17 FY18 FY19 FY20e FY21e Total Net Loans (OMR mn) 2,654 2,810 2,802 2,816 2,962 Total Customer Deposits (OMR mn) 2,461 2,452 2,532 2,568 2,726 Operating Income (OMR mn) 132 129 128 127 127 Net Profit (OMR mn) 44 51 51 39 43 Diluted EPS (OMR) 0.028 0.031 0.032 0.024 0.026 Diluted BVPS (OMR) 0.278 0.259 0.270 0.261 0.267 P/E (x)* 6.7 5.8 5.8 6.5 6.0 Ayisha Zia P/BVPS (x)* 0.68 0.70 0.68 0.60 0.59 Research Analyst Dividend Yield (%)* 7.9% 8.8% 9.1% 6.4% 9.6% [email protected] Source: Bank Financials, U Capital Research Tel: +968 24 94 90 36 * Market price for the current and subsequent years as per the closing price of 05-May-2020

Page 26 of 38

National Bank of Oman SAOG

Asset quality has deteriorated although provisioning is adequate

NBOs’ NPLs have risen rapidly over 2016-2018 mainly due to its UAE exposure. In 2019, NPL growth was much slower, with total NPLs at 4.9% of total gross loans & Islamic financing. Provision coverage has also rapidly declined to 82.4% from 100%+ levels before 2018. We expect cost of risk to rise in 2020, due to the current macroeconomic situation in 2020. Beyond 2020, we have assumed some reduction in cost of risk as macroeconomic situation is expected to ease. NBOB: Asset Quality NBOB: Capital Adequacy 6.0% 160% 140% 20.0% 5.0% 120% 4.0% 15.0% 100% 3.0% 80% 10.0% 60% 2.0% 40% 5.0% 1.0% 20% 0.0% 0.0% 0% FY13 FY14 FY15 FY16 FY17 FY18 FY19 1 2 3 4 5 6 7 8

NPLs ratio (LHS) Coverage (RHS) Tier 1 Capital Ratio Tota Capital Adequacy Ratio (CAR)

Source: Company Financials, U Capital Research

NBO’s capital adequacy, even though higher than CBO’s minimum requirements, is the lowest amongst its local peer-group. Even though 2019 witnessed some contraction in risk-weighted assets, and capital increased, CAR grew only by a small notch. Since net profit is expected to fall in 2020, we believe that the bank’s CAR will come under pressure.

Spread contraction amid loan-book growth stagnation As interest & Islamic finance yield growth remains under pressure on account of low loan-book growth & intense competition amongst the sector participants, the bank’s spread expansion has stalled. As long as loan-book expansion remains under pressure, we do not expect to see an improvement in spread expansion, at least in the near term. Customer deposits have increased by 3.2%YoY in 2019 vs. a net loans decline of 0.3%.

NBOB: Spread NBOB: Key growth drivers 6.0% 15.0% 5.0% 10.0% 4.0% 5.0% 3.0% 0.0% 2.0% -5.0% 1.0%

0.0% 2014 2015 2016 2017 2018 2019 2014 2015 2016 2017 2018 2019 2020e Total Loans & Islamic Financing Total deposits

Source: Company Financials, U Capital Research

Investments in information technology led operating expense growth in 2019, while revenues fell 0.5%YoY mainly due to a 13%YoY contraction in fee income. Consequently, NBO’s cost-to-income reached a nine-year peak of 49.6% in 2019 vs. an average of 47.5% for the local peer-group. We expect its cost-to-income ratio to remain elevated at 49% during 2020-21 as revenue generation weakens and operating expense reduction opportunities remain limited.

Page 27 of 38

National Bank of Oman SAOG

Key Financials (OMR mn) 2017 2018 2019e 2020e 2021e 2022e Income Statement Interest/Financing Income 150.4 158.9 171.4 166.8 167.1 176.3 Interest Expense/Payment to Depositors (57.5) (66.6) (77.4) (73.6) (75.7) (80.0) Net Interest/Financing Income 92.9 92.4 94.0 93.2 91.4 96.3 Fee & Commission Income 19.5 22.4 19.6 19.4 19.2 19.0 Other Income 19.7 14.3 14.7 14.6 16.5 18.8 Total Non-Interest/Financing Income 39.2 36.6 34.3 34.0 35.7 37.8

Total Operating Income 132.1 129.0 128.3 127.2 127.0 134.1 Operating Expenses (64.5) (61.7) (63.6) (63.0) (62.3) (65.1) Operating Profit 67.6 67.3 64.7 64.2 64.7 69.0 Provisions expense (16.4) (7.4) (7.7) (18.8) (15.7) (15.0) Profit Before Taxation 51.3 59.9 57.0 45.4 49.0 54.0 Taxation (7.2) (9.3) (5.5) (5.9) (6.3) (6.4) Net Profit 44.0 50.6 51.4 39.4 42.8 47.6 Interest on Tier 1 Perpetual Securities (9.1) (9.1) (9.1) (9.1) (9.1) (9.1) Net Profit Attributable to shareholders 34.9 41.5 42.3 30.3 33.7 38.5 Balance Sheet Cash Balances 383 315 334 494 520 553 Deposits with Banks & FIs 139 98 109 122 128 136 Net Loans & Islamic financing 2,537 2,810 2,802 2,816 2,962 3,144 Investments 183 231 293 131 137 146 Net Fixed Assets 66 64 67 69 71 73 Other Assets 229 3,095 3,135 2,988 3,142 3,336 Total Assets 1,000 3,573 3,645 3,673 3,861 4,098

Deposits from Banks & FIs 126 156 284 288 306 327 Total Customer Deposits 2,461 2,452 2,532 2,568 2,726 2,921 Other Borrowings 371 440 308 308 308 308 Other Liabilities 81 104 83 83 88 93 Total liabilities 2,899 3,019 3,091 3,132 3,311 3,534

Paid-up Capital 155 163 163 163 163 163 Retained Earnings 135 127 161 171 176 186 Other Reserves 141 131 115 91 95 100 Shareholders' Equity 431 421 438 425 434 449 Tier 1 Perpetual Notes 116 116 116 116 116 116 Total Equity & Liabilities 3,470 3,573 3,645 3,673 3,861 4,098 Cash Flow Statement Cash from operations (45) 3 78 221 68 75 Cash from investing activities 24 3 8 8 8 9 Cash from financing (60) (68) (51) (53) (33) (33) Net changes in cash (128) (68) 19 161 26 33 Cash at the end of period 383 315 334 494 520 553 Key Ratios Return on Average Assets 1.0% 1.4% 1.4% 1.1% 1.1% 1.2% Return on Average Equity 10.3% 11.9% 12.0% 9.1% 9.9% 10.8% Net Interest & Islamic Finance Income / Operating Income 68.4% 69.4% 70.6% 73.3% 71.0% 66.3% Other operating income / Operating Income 31.6% 30.6% 29.4% 26.7% 29.0% 33.7% Net fee Income/Operating Income 14.8% 17.3% 15.3% 15.2% 15.1% 14.2% Interest Earning/Financing Assets Yield 4.92% 4.99% 5.16% 5.32% 5.31% 5.30% Cost of Funds -1.93% -2.18% -2.46% -2.43% -2.42% -2.40% Net Spread 2.98% 2.81% 2.70% 2.89% 2.89% 2.90% Cost to Income Ratio 48.8% 47.9% 49.6% 49.5% 49.0% 48.5% Net Loans & Islamic Financing to Customer Deposits (Total LTD) 107.8% 114.6% 110.7% 109.7% 108.7% 107.7% NPLs to Gross Loans & Islamic financing 4.1% 4.8% 4.9% 5.0% 5.1% 5.2% NPL Coverage, % 103.1% 92.8% 82.4% 89.7% 85.0% 80.5% Cost of Risk, bps 55.5 24.2 24.4 60.0 50.0 45.0 Shareholders' Equity to Total Loans & Islamic Financing, x 0.20 0.18 0.19 0.18 0.18 0.17 Shareholders' Equity to Total Assets, x 0.16 0.15 0.15 0.15 0.14 0.14 Capital Adequacy Ratio, % 17.3% 16.3% 16.7% 16.9% 16.4% 15.7% EPS, OMR 0.028 0.031 0.032 0.024 0.026 0.029 BVPS, OMR 0.278 0.259 0.270 0.261 0.267 0.276 Market Price, OMR* 0.190 0.182 0.184 0.157 0.157 0.157 Cash Dividend Payout Ratio, % 52.8% 51.4% 53.1% 41.2% 57.0% 51.2% Cash Dividend Yield, % 7.9% 8.8% 9.1% 6.4% 9.6% 9.6% P/E Ratio, x 6.7 5.8 5.8 6.5 6.0 5.4 P/BV Ratio , x 0.7 0.7 0.7 0.6 0.6 0.6 *Market price for current year and subsequent years as per the closing price on 05-May-2020 Source: Company Financials, U Capital Research

Page 28 of 38

Sohar International Bank SAOG

TP: OMR 0.080 per share Sohar International Bank SAOG Upside/ (Downside): (2.4%)

Recommendation HOLD • Faster loan growth than sector (+9%YoY as of FY19 vs. Oman credit growth of Bloomberg Ticker BKSB OM 3.1%YoY) Current Market Price (OMR) 0.082 • Loan-to-deposit ratio stretched at 117%; one of the highest within peer group 52wk High / Low (OMR) 0.110/0.080 • NPLs have jumped to 4.8% of Gross loans in FY19; provision cover down to 93% 12m Average Vol. (000) 431.0 due to a large NPL rise of 61%YoY Mkt. Cap. (USD/OMR Mn) 519/200 Free Float (%) 70% We maintain our rating for BKSB at HOLD but reduce the target price to OMR 0.080 3m Avg Daily Turnover (OMR'000) 30.5 on revision of forecast and higher cost of equity. Our target price implies a P/E’20e 6m Avg Daily Turnover (OMR'000) 36.1 and a P/B’20e of 6.5x and 0.56x respectively. We believe that this target price is P/E'20e (x) 7.7 justified because (1) the bank’s core equity Tier 1 (CET1) ratio is low as compared to P/B'20e (x) 0.66 Dividend Yield '20e (%) 6.4% peers at 10.56% making it more vulnerable to the current crisis situation (2) its net interest margin is one of the lowest amongst the sector with LTD stretched at 117% Price Performance: making it susceptible to liquidity squeeze in times of low prices (3) its asset quality 1 month (%) (2.38) has declined and we expect the trend to continue due to the ongoing crisis.

3 month (%) (23.22) Valuation & Outlook 12 month (%) (23.68) Our TP is derived using a weighted average of excess returns methodology and peer- Source: Bloomberg group price-book multiple for FY20e. We have used a discount rate of 16.5% for the bank and a perpetual growth rate of 4.4% for the terminal value. The key upside Price-Volume Performance risks to our TP are improvement in NIMs and a lower-than-expected cost of risk. The bank has shown improvement in its net interest margin, which has resulted in its 0.120 8,000 net interest income & Islamic finance income to grow by 24%YoY during FY19, 7,000 0.110 6,000 buoyed by 9%YoY net loan & Islamic finance asset growth. Due to the current 0.100 5,000 macroeconomic scenario, we expect BKSB’s NIMs to be eroded amid loan growth 0.090 4,000 slow-down, leading to flat net profit growth in 2020. The bank’s operating margin is 3,000 0.080 expected to improve over the forecast horizon. The key downside risks to our 2,000 valuation are a lower-than-expected improvement in net interest margin and a 0.070 1,000 further deterioration in asset quality resulting in cost of risk to rise weighing down 0.060 - its net profit. Jul-19 Jan-20 Jun-19 Oct-19 Apr-20 Sep-19 Feb-20 Dec-19 Aug-19 Nov-19

Mar-20 Lackluster Operating performance for 1Q20 May-19

Vol, '000 (RHS) Px, OMR (LHS) The bank’s 1Q20 results have been lackluster, with operating income decline of 9.3%YoY and 24.7%QoQ. Even though operating expenses have declined by

Source: Bloomberg 7.5%YoY and 7.2%QoQ, operating profit has declined by 10.9%YoY and 35.4%QoQ. A net ECL charge of OMR 5.0mn has been booked in 1Q20, pointing to a reduction in cost of risk for the quarter from the previous quarter. However, this charge still

remains double of that booked in 1Q19. The bank's net loans & Islamic financing as

well as customer deposits were in line with our estimates. Income Statement (OMR mn) 1Q19 4Q19 1Q20 YoY (%) QoQ (%) Operating Income 25.4 30.6 23.1 -9.3% -24.7% Operating Expenses (11.7) (11.6) (10.8) -7.5% -7.2% Ayisha Zia Operating Profit 13.8 19.0 12.3 -10.9% -35.4% Research Analyst Net ECL charge (2.5) (6.0) (5.0) 98.3% -16.5% [email protected] PBT 11.3 13.0 7.3 -35.5% -44.2% Tax (1.1) (3.7) (1.1) -1.0% -70.2% Tel: +968 24 94 90 36 Net Profit 10.2 9.3 6.2 -39.2% -34.0%

Page 29 of 38

Sohar International Bank SAOG

Weaker funding mix to drag on NIMs amid liquidity squeeze BKSB’s cost of funding is higher than its peers given that it has only 62% of its balance sheet funded by customer deposits. The bank has been resorting to expensive interbank (c21% of assets, net borrower of OMR 537mn) and wholesale markets to fund its rapid loan growth, which has resulted in creating a drag on its NIM. We expect funding cost to remain stretched and asset yields to drop, resulting in NIM contraction for the bank over the forecast period. Furthermore, even though it has increased its low-cost CASA mix to (slightly above peer-group average 52.8%) 54% in 2019 vs. 43% in 2018, we expect to see funding cost stretched for some time.

BKSB: Spreads BKSB: Funding Mix, FY19 Tier 1 6.00% Perpetual Bonds 5.00% Shareholders' 6% Equity Due to banks 4.00% 4.88% 4.92% 4.87% 4.53% 10% 21% 3.00% Borrowings 2.94% 2.00% 2.67% 2.82% 2.81% 1% 1.00%

0.00% FY16 FY17 FY18 FY19 Customer Deposits Yield on interest earning assets 62% Cost of interest bearing liabilities

Source: Company Financials, U Capital Research

Capital adequacy likely to be affected through asset quality deterioration BKSB’s loan book has grown faster than the sector at about a CAGR of 12% between 2014-19, above the sector’s CAGR of 5%. Additionally, its loan-book is skewed towards the corporate segment, like Ahli Bank (ABOB), and within corporate, it is more concentrated in construction, services and wholesale &retail trade sectors, which will likely be more harshly affected by the ongoing crisis. We expect cost of risk for the bank to rise to 70bps vs 61bps in 2019 (already quite high vs. peer-group average at 39bps).

BKSB: Asset quality metrics BKSB: Capital Adequacy Ratios

18.6% 6.0% 140.0% 20.0% 17.9% 18.0% 4.8% 4.8% 120.0% 16.2% 5.0% 16.0% 15.0% 100.0% 4.0% 14.0% 3.3% 11.3% 80.0% 12.0% 2.5% 3.0% 2.3% 10.0% 60.0% 8.0% 2.0% 40.0% 6.0% 4.0% 1.0% 20.0% 2.0% 0.0% 0.0% 0.0% FY16 FY17 FY18 FY19 FY20e FY16 FY17 FY18 FY19 FY20e

NPLs to Gross Loans & Islamic Financing, x NPL Coverage, x Tota Capital Adequacy Ratio (CAR) Tier 1 Capital Ratio

Source: Company Financials, U Capital Research The bank’s CET1 ratio at 10.6% is the lowest amongst local peers and below the simple average of 13.7%. Although CBO has reduced its CET 1 requirement to 8.25% from 9.50% (Capital Conservation Buffer has been cut by 125bps to 1.25%) to tackle the current COVID- 19 crisis, BKSB’s core equity capital ratio is looking low, in our view. We believe that BKSB’s dividend for 2020 might be under pressure, as the CBO already revised its DPS proposal for 2019 from OMR 0.006 per share to OMR 0.003 per share. BKSB has successfully raised common equity through rights issues, most recent one being in Jul’19, but its CET1 ratio continues to remain low within the sector. We believe that BKSB will not be raising any more capital this year, pointing to constraint on its adequacy levels due to the ongoing crisis.

Page 30 of 38

Sohar International Bank SAOG

Key Financials (OMR mn) 2017 2018 2019 2020e 2021e 2022e Income Statement Interest/Financing Income 109.3 130.3 146.7 158.0 166.9 177.0 Interest Expense/Payment to Depositors (61.6) (73.7) (76.5) (86.3) (95.8) (102.9) Net Interest/Financing Income 51.5 61.3 76.0 78.4 78.8 83.0 Other Income 6.4 17.4 28.6 28.1 28.1 28.4 Total Non-Interest/Financing Income 24.6 33.1 28.6 28.1 28.1 28.4

Total Operating Income 76.1 94.4 104.7 106.4 106.9 111.4 Operating Expenses (35) (40) (45) (46) (46) (48) Operating Profit 41.3 54.6 59.4 60.7 61.1 63.7 Provisions expense (11.7) (20.1) (18.8) (25.4) (25.3) (25.4) Profit Before Taxation 29.6 34.4 40.5 35.3 35.8 38.3 Taxation (4.6) (5.1) (6.1) (5.3) (5.4) (5.8) Net Profit 25.0 29.4 34.4 29.9 30.4 32.6 Interest on Tier 1 Perpetual Securities 7.8 7.8 13.4 15.3 15.3 15.3 Net Profit Attributable to shareholders 17.3 21.6 21.0 14.7 15.1 17.3 Balance Sheet Cash Balances 182 72 90 354 364 379 Deposits with Banks & FIs 104 121 198 135 145 157 Net Loans & Islamic financing 2,099 2,252 2,454 2,650 2,862 3,091 Investments 414 533 637 688 744 803 Investment Properties 3 3 3 3 3 3 Net Fixed Assets 17 20 38 38 38 38 Other Assets 24 45 84 91 98 106 Total Assets 2,843 3,046 3,505 3,960 4,255 4,577

Deposits from Banks & FIs 737 723 736 995 1,080 1,171 Total Customer Deposits 1,643 1,818 2,097 2,275 2,467 2,675 Other Borrowings 38 35 35 33 31 29 Other Liabilities 31 85 101 109 118 128 Total liabilities 2,449 2,661 2,969 3,412 3,695 4,003

Paid-up Capital 178 198 236 243 251 258 Retained Earnings 73 39 39 39 40 42 Other Reserves 42 48 61 65 70 74 Shareholders' Equity 294 285 336 348 360 374 Tier 1 Perpetual Notes 100 100 200 200 200 200 Total Equity & Liabilities 2,843 3,046 3,505 3,960 4,255 4,577 Cash Flow Statement Cash from operations 85 52 24 336 86 94 Cash from investing activities 64 122 123 51 55 59 Cash from financing 41 (40) 116 (21) (21) (20) Net changes in cash 63 (110) 17 264 11 14 Cash at the end of period 182 72 90 354 364 379 Key Ratios Return on Average Assets 0.9% 1.0% 1.1% 0.8% 0.7% 0.7% Return on Average Equity 8.8% 10.1% 11.1% 8.8% 8.6% 8.9% Net Interest & Islamic Finance Income / Operating Income 67.7% 64.9% 72.7% 73.6% 73.7% 74.5% Other operating income / Operating Income 32.3% 35.1% 27.3% 26.4% 26.3% 25.5% Net fee Income/Operating Income 23.9% 16.6% 0.0% 0.0% 0.0% 0.0% Interest Earning/Financing Assets Yield 4.53% 4.88% 4.92% 4.87% 4.83% 4.76% Cost of Funds 2.67% 2.94% 2.82% 2.81% 2.80% 2.78% Net Spread 1.86% 1.95% 2.09% 2.05% 2.03% 1.98% Cost to Income Ratio 45.7% 42.2% 43.3% 43.0% 42.9% 42.8% Net Loans & Islamic Financing to Customer Deposits (Total LTD) 127.8% 123.8% 117.0% 116.5% 116.0% 115.5% NPLs to Gross Loans & Islamic financing 2.3% 3.3% 4.8% 4.8% 4.8% 4.9% NPL Coverage, % 99.4% 115.3% 93.0% 93.0% 93.1% 93.1% Cost of Risk, bps 46.9 72.8 60.8 75.0 70.0 65.0 Shareholders' Equity to Total Loans & Islamic Financing, x 0.14 0.12 0.13 0.13 0.12 0.12 Shareholders' Equity to Total Assets, x 0.10 0.09 0.10 0.09 0.08 0.08 Capital Adequacy Ratio, % 16.2% 15.0% 18.6% 17.8% 17.0% 16.3% EPS, OMR 0.014 0.015 0.015 0.012 0.012 0.013 BVPS, OMR 0.165 0.144 0.142 0.143 0.143 0.145 Market Price, OMR* 0.152 0.111 0.110 0.094 0.094 0.094 Cash Dividend Payout Ratio, % 35.7% 40.5% 41.2% 48.8% 49.6% 47.6% Cash Dividend Yield, % 3.3% 5.4% 5.5% 6.4% 6.4% 6.4% P/E Ratio, x 10.8 7.5 7.6 7.7 7.8 7.5 P/BV Ratio , x 0.9 0.8 0.8 0.7 0.7 0.7 *Market price for current year and subsequent years as per the closing price on 05-May-2020 Source: Company Financials, U Capital Research

Page 31 of 38

Ahli Bank SAOG

TP: OMR 0.126 / share Ahli Bank SAOG Upside /(Downside): 5.0%

Recommendation Hold • Superior efficiency, lowest cost-to-income amongst peers at ~39.6% (sector: ~47.5%) Bloomberg Ticker ABOB OM • Spreads improving in spite of the bank’s high dependence on costlier time deposits (c65% Current Market Price (OMR) 0.120 of total deposits vs. peer average at 52.8%) 52wk High / Low (OMR) 0.140/0.110 • Capital adequacy ratio at 17.06%, well-above the regulatory minimum; CET1 ratio at 12m Average Vol. (000) 122.8 10.62% is at the lower end of peers Mkt. Cap. (USD/OMR Mn) 515/198 Shares Outstanding (mn) 1,649.7 We revise our rating on Ahli Bank at Hold and reduce its the target price OMR 0.126 per Free Float (%) 94% share. Our target price implies a P/e’20e and a P/B’20e of 7.3x and 0.75x respectively. 3m Avg Daily Turnover (OMR'000) 13.7 We believe that this target price is justified because (1) earnings growth might be 6m Avg Daily Turnover (OMR'000) 11.9 hampered due to the current macroeconomic environment, (2) the bank has shown P/E'20e (x) 7.0 P/B'20e (x) 0.7 consistent performance with no surprises but we have revised our estimates down for Cash Dividend Yield '20e (%) 8.3% 2020 and beyond given the current situation, (3) superior-than-sector average ROE justifies a higher P/e multiple as compared to some peers, (4) low CET1 ratio (despite Price Performance: being above regulatory threshold) might negatively affect dividend pay-out for this year. 1 month (%) (8.40) 3 month (%) (13.70) Valuation & Outlook 12 month (%) 5.88 We have used a cost of equity of 13.5% for our model, which is lower than the sector Source: Bloomberg on a lower Beta (Source: Bloomberg 2 Yr Avg Weekly) as the stock trades less. We believe that the bank will be able to grow its net profit at a CAGR of 5% over 2020-2024F, Price-Volume Performance on the back of improving net loan growth as the country’s GDP growth picks up pace. However, for 2020, our outlook suggests net profit decline on limited operating income 0.150 3,500 growth and higher cost of risk. We have assumed a conservative growth in its net loans 3,000 0.140 & advances (CAGR: 7.5%) which will drive growth in net interest income after 2020. Its 2,500 0.130 other operating income is expected to grow at a CAGR of 6.0% over the forecast period, 2,000 0.120 resulting in an operating income growth of 5% in spite of a slower growth in total 1,500 0.110 interest & Islamic finance income. The bank’s cost of risk is expected to rise in 2020 1,000 before beginning to taper off towards the end of the forecast period. We further believe 0.100 500 that the bank will be able to maintain its operating cost-to-income ratio at the current 0.090 - levels. The bank has historically relied heavily on term funding resulting in higher than

Jul-19 peer-group average cost of funding. However, recently the bank has raised capital Jan-20 Jun-19 Oct-19 Apr-20 Sep-19 Feb-20 Dec-19 Aug-19 Nov-19 Mar-20 May-19 through a further issuance of OMR 20mn worth of Tier1 perpetual notes, thereby Vol, '000 (RHS) Px, OMR (LHS) improving its funding profile. We expect this to support its spreads.

Source: Bloomberg Faster deterioration in asset quality is likely to pose downside risk to our valuation. On the other hand, slower than expected deterioration of asset quality is and faster loan growth is likely to offer an upside to our valuation.

Key Indicators Year FY-17 FY - 18 FY-19 FY-20e FY-21e Total Net Loans (OMR mn) 1,634 1,871 2,055 2,158 2,309 Total Customer Deposits (OMR mn) 1,662 1,712 1,827 1,947 2,074 Operating Income (OMR mn) 55 62 70 71 74 Net Profit (OMR mn) 27 29 31 28 30 Ayisha Zia Diluted EPS (OMR) 0.019 0.019 0.020 0.017 0.017 Diluted BVPS (OMR) 0.179 0.170 0.169 0.168 0.172 Research Analyst P/E (x) 9.2 7.6 6.6 7.0 7.0 [email protected] P/BVPS (x) 1.0 0.9 0.8 0.7 0.7 Tel: +968 24 94 90 36 Source: Company Financials, U Capital Research * Market price for the current and subsequent years as per the latest closing price of 05/05/2020

Page 32 of 38

Ahli Bank SAOG

Low CASA deposit mix to weigh on NIMs in a falling interest rate environment Yield on interest earning assets of the bank has improved significantly with rising interest rates and asset re-pricing over the last few years. However, cost of funding has also risen which has dampened spread expansion. Still, spreads have improved, albeit slowly. However, with the recent interest rate cuts and subdued macroeconomic environment, we expect NIMs to stay under pressure. Furthermore, ABOB has lowest low-cost CASA deposits as compared to its local peers, pointing to pressure to build up on its NIMs. ABOB: Customer Deposit Mix ABOB: Spreads

6.00% CASA 35% 5.00% 4.00% 3.00% Term & 2.00% Others 1.00% 65% 0.00% 2015 2016 2017 2018 2019 2020e Cost of interest bearing liabilities CASA Term & Others Yield on interest earning assets

Figure Source: Company Financials, U Capital Research

Superior efficiency within the sector Ahli bank boasts superior efficiency with cost-to-income ratio at 39.6% and cost to average total assets at 1.1% for FY19. The bank is more cost efficient than its listed local peers. Hence, we believe that the bank is uniquely positioned to benefit from the current situation due to its relatively higher efficiency. ABOB: Operational Efficiency Metrics ABOB: Asset qality metrics

42.0% 1.2% 1.50 2.0% 1.2% 40.0% 1.5% 1.1% 1.00 38.0% 1.1% 1.0% 36.0% 1.0% 0.50 0.5% 34.0% 1.0% 32.0% 0.9% 0.00 0.0% 2015 2016 2017 2018 2019 2020e 2015 2016 2017 2018 2019 2020e NPL Coverage, x Cost-to-Income Ratio Cost to Average Total Assets NPLs to Gross Loans & Gross Islamic Financing, x re Source: Company Financials, U Capital Research The bank’s return on average equity is one of the highest within its peer group at 11.9% in 2019. However, its return on average equity after interest expense on Tier 1 securities is mediocre at 8.6%.

Asset quality might deteriorate ABOB, like BKSB, has characteristically been more focused on corporate banking services, with corporate share of loans at 65%. Within corporates, ABOB has the highest exposure to the construction sector within its own portfolio as well as the highest exposure within peers, at 22%. We expect that given the ongoing pandemic and reduced Government budgets, construction sector is most likely to be hit with likely NPL formation for ABOB. However, the CBO has mandated deferral of the risk classification of loans pertaining to Government projects for a period of 6 months. This should support asset quality. It is worth noting that ABOB has an NPL provision cover of 1.14x, which is higher than sector average of 0.88x.

Page 33 of 38

Ahli Bank SAOG

Key Financials (OMR mn) FY-17 FY - 18 FY-19 FY-20e FY-21e FY-22e Income Statement Interest/Financing Income 90 108 125 133 141 150 Interest Expense/Payment to Depositors (46) (56) (68) (76) (83) (87) Net Interest/Financing Income 45 52 57 58 58 63 Other Income 10 10 13 14 16 17 Total Non-Interest/Financing Income 10 10 13 14 16 17

Total Operating Income 55 62 70 71 74 79 Operating Expenses (19) (23) (28) (28) (29) (32) Operating Profit Provisions expense (4) (5) (6) (11) (10) (10) Profit Before Taxation 32 34 36 32 34 38 Taxation (5) (5) (5) (4) (4) (5) Net Profit 27 29 31 28 30 33 Interest on Tier 1 Perpetual Securities - (4) (9) (9) (9) (9) Net Profit Attributable to shareholders 27 25 22 20 21 25 Balance Sheet Cash Balances 117 153 108 140 133 117 Deposits with Banks & FIs 17 24 50 54 58 62 Net Loans & Islamic financing 1,634 1,871 2,055 2,158 2,309 2,471 Investments 217 214 258 271 290 310 Net Fixed Assets 17 17 21 23 26 28 Other Assets 13 11 25 25 25 25 Total Assets 2,015 2,290 2,519 2,672 2,841 3,014

Deposits from Banks & FIs 134 147 198 211 225 240 Total Customer Deposits 1,451 1,662 1,712 1,827 1,947 2,074 Other Borrowings 83 77 144 153 161 171 Other Liabilities 43 46 76 81 86 92 Total liabilities 1,710 1,931 2,129 2,271 2,419 2,577

Paid-up Capital 143 150 157 165 173 173 Retained Earnings 66 55 55 56 65 77 Other Reserves 46 50 53 56 60 63 Shareholders' Equity 255 255 265 277 297 313 Tier 1 Perpetual Notes 50 104 124 124 124 124 Total Equity & Liabilities 2,015 2,290 2,519 2,672 2,841 3,014 Cash Flow Statement Cash from operations 21 10 12 64 23 25 Cash from investing activities 40 (2) 48 15 21 23 Cash from financing (5) 25 (9) (17) (9) (17) Net changes in cash (24) 37 (45) 32 (8) (15) Cash at the end of period 117 153 108 140 133 117 Key Ratios Return on Average Assets 1.4% 1.3% 1.3% 1.1% 1.1% 1.1% Return on Average Equity 10.7% 11.3% 11.9% 10.5% 10.4% 10.9% Net Interest & Islamic Finance Income / Operating Income 81.1% 83.8% 81.8% 80.7% 78.8% 78.9% Other operating income / Operating Income 18.9% 16.2% 18.2% 19.3% 21.2% 21.1% Net fee Income/Operating Income 0.0% 0.0% 14.3% 14.3% 14.3% 14.3% Interest Earning/Financing Assets Yield 5.0% 5.4% 5.6% 5.5% 5.5% 5.4% Cost of Funds 2.0% 2.1% 2.8% 2.9% 3.0% 2.9% Net Spread 5.0% 5.4% 5.5% 5.5% 5.5% 5.4% Cost to Income Ratio 35% 37% 40% 40% 40% 40% Net Loans & Islamic Financing to Customer Deposits (Total LTD) 112.7% 112.6% 120.1% 118.1% 118.6% 119.1% NPLs to Gross Loans & Islamic financing 1.2% 1.7% 1.7% 1.8% 1.8% 1.8% NPL Coverage, % 125.9% 104.9% 114.0% 110.2% 109.7% 109.1% Cost of Risk, bps 19.9 25.7 26.3 50.0 45.0 40.0 Shareholders' Equity to Total Loans & Islamic Financing, x 0.15 0.13 0.13 0.13 0.13 0.12 Shareholders' Equity to Total Assets, x 0.13 0.11 0.11 0.10 0.10 0.10 Capital Adequacy Ratio, % 16.7% 17.5% 17.1% 16.3% 16.0% 15.5% EPS, OMR 0.019 0.019 0.020 0.017 0.017 0.019 BVPS, OMR 0.179 0.170 0.169 0.168 0.172 0.181 Market Price, OMR* 0.173 0.146 0.130 0.120 0.120 0.120 Cash Dividend Payout Ratio, % 53.4% 52.0% 50.7% 58.2% 58.0% 52.1% Cash Dividend Yield, % 5.8% 6.8% 7.7% 8.3% 8.3% 8.3% P/E Ratio, x 9.2 7.6 6.6 7.0 7.0 6.3 P/BV Ratio , x 1.0 0.9 0.8 0.7 0.7 0.7 *Market price for current year and subsequent years as per the closing price on 05-May-2020 Source: Company Financials, U Capital Research

Page 34 of 38

HSBC Bank Oman SAOG

TP: OMR 0.101 / share HSBC Bank Oman SAOG Upside/ (Downside): 7%

Recommendation Hold • Superior spreads at ~2.8% compared to sector simple average of 2.3% Bloomberg Ticker HBMO OM • Lowest Loan-to-Deposit Ratio at 72.5% within the sector (peer-group average: 106%), Current Market Price (OMR) 0.094 providing ample room to grow 52wk High / Low (OMR) 0.130/0.090 • Well capitalized with CAR at 18.7% 12m Average Vol. (000) 217.0 Mkt. Cap. (USD/OMR Mn) 489/188 We revise our rating and target price on HBMO as HOLD and OMR 0.101 per share Shares Outstanding (mn) 2,000.3 respectively, implying a P/E’20e of 9.0x and a P/B’20e of 0.56x. We believe that the Free Float (%) 49% bank faces a challenging operating environment, high concentration risks and 3m Avg Daily Turnover (OMR'000) 15.3 below-average profitability. On the other hand, the bank's adequate domestic 6m Avg Daily Turnover (OMR'000) 16.3 franchise, competent management, a lower risk appetite compared with domestic P/e'20e (x) 8.7 peers, good risk controls, solid capital ratios and stable funding and liquidity are P/b'20e (x) 0.52 expected to support the bank’s valuations. Dividend Yield '20e (%) 6.8% Valuation & Outlook We believe that the bank will be able to grow its net loan book at a CAGR of 3.0 % Price Performance: over the forecast period. We have been conservative in our estimates as the bank 1 month (%) (10.48) has low risk appetite. Our estimates for top line as well bottom line growth are also 3 month (%) (21.67) conservative. We have used a cost of equity of 13.8% for the bank and a terminal 12 month (%) (21.67) sustainable growth rate of 4.8%. Source: Bloomberg HBMO's funding and liquidity profile is better than peers, with a low gross loans-to- customer deposits ratio, which partial mitigates high deposit concentration risk.

Customer deposits represent about 94% of total funding as at the end of 2019 Price-Volume Performance reflecting the bank's strong deposit gathering capability. Deposit concentration is 0.140 7,000 high, with the largest 20 deposits accounting for more than half of total customer deposits, although they have historically been sticky. Non-deposit funding is limited 0.130 6,000 and includes a small amount of interbank funding (FY19: 3% of total funding). HBMO 5,000 0.120 is a liquidity provider in the domestic interbank market with due from banks to due 4,000 0.110 to banks ratio at 375%. This puts HBMO in a unique position to have a low cost of 3,000 funding at 0.79% vs all peers being above 2%. In times of falling interest rates, like 0.100 2,000 now, HBMO can defend its net interest margin better than peers. Nonetheless, we

0.090 1,000 have conservatively assumed a fall in net profit for 2020 on higher cost of risk despite operating income growth, based on 1Q20 net loss amid the given current 0.080 - macroeconomic situation. Jul-19

Jan-20 The key upside risks to our valuation are: (1) better-than-expected loan growth (2) Jun-19 Oct-19 Apr-20 Sep-19 Feb-20 Dec-19 Aug-19 Nov-19 Mar-20 May-19 Any significant improvements in macroeconomic situation The key downside risks Vol, '000 (RHS) Px, OMR (LHS) to our valuation are: (1) NPLs rising faster than anticipated (2) A prolonged Source: Bloomberg deterioration in macroeconomic outlook of the country, resulting in slower credit offtake as well as reduced liquidity

Key Indicators Year FY17 FY18 FY19 FY20e FY21e Total Net Loans (OMR mn) 1,395 1,390 1,503 1,517 1,592 Total Customer Deposits (OMR mn) 1,932 1,926 2,071 2,077 2,165 Operating Income (OMR mn) 75 86 87 89 90 Net Profit (OMR mn) 19 31 29 22 24 Ayisha Zia Diluted EPS (OMR) 0.010 0.016 0.015 0.011 0.012 Research Analyst Diluted BVPS (OMR) 0.162 0.170 0.176 0.180 0.185 [email protected] P/E (x) 13.4 7.6 8.3 8.7 7.9 Tel: +968 24 94 90 36 P/BVPS (x) 0.79 0.70 0.69 0.52 0.51 Dividend Yield (%) 4.5% 7.8% 7.2% 6.8% 7.6% Source: Bank Financials, U Capital Research *Market price for the current and subsequent years based on the closing price of 05/05/2020

Page 35 of 38

HSBC Bank Oman SAOG

Strong capitalization can support asset quality deterioration HBMO’s capital ratios stood strong at the end-FY19, with CET1 18.0% and total capital at 18.8%, maintained comfortably above minimum requirements. HBMO’s modest loan growth and consistent organic capital generation support its capital adequacy. HBMO: Capital adequacy HBMO: Asset Quality

25.0% 6.0% 130.0% 125.0% 20.0% 5.0% 120.0% 4.0% 15.0% 115.0% 3.0% 10.0% 110.0% 2.0% 105.0% 5.0% 1.0% 100.0% 0.0% 0.0% 95.0% 2016 2017 2018 2019 2020e 2016 2017 2018 2019 2020e Tier 1 Capital Ratio Tota Capital Adequacy Ratio (CAR) NPLs to Gross Loans, x NPL Coverage, x

Non-perming loans were somewhat stable at 4.5% of gross loans in 2019, which is higher than the sector average, largely due to some legacy non-performing loans inherited from OIB. We expect some credit deterioration during 2020 given the challenging operating environment. We expect the bank’s cost of risk to rise, given its provision cover having fallen somewhat from historical levels. HBMO has moderate exposure to the cyclical commercial real estate and construction sectors (c6%), with highest exposure to import trade and manufacturing (at 13% each, as a % of its total portfolio) but its high proportion of liquid assets (largely cash and government securities) supports its balance sheet strength (Liquidity Coverage Ratio at 290% as at FY19-end).

Cost efficiency to improve albeit slowly; cost of risk to rise in 2020 HBMO’s cost efficiency ratios are weaker than its peers, although they have been improving driven by an optimization of its branch network and elimination of inefficiencies inherited from its merger with OIB. The bank's cost-to-income ratio was 56% in 2019 vs. peer-group average of about 48%

HBMO: Efficiency metrics HBMO: Cost of risk

2.2% 66.0% 70 2.2% 64.0% 60 2.1% 62.0% 50 2.1% 60.0% 40 2.0% 58.0% 30 2.0% 56.0% 20 1.9% 54.0% 10 1.9% 52.0% 0 1.8% 50.0% -10 2016 2017 2018 2019 2020e -20 Cost to Avg Total Assets (LHS) 2016 2017 2018 2019 2020e Cost-to-Income Ratio (RHS)

Source: U Capital Research

The bank’s cost of risk of interest earning assets at 16bps in FY19 is the lowest amongst its peers, and compares well to its peer-group simple average of 39.5bps. We believe, however, that as its provision coverage is on the lower side, its cost of risk should see an increase in 2020. We have conservatively assumed cost of risk to remain high over the forecast period.

Page 36 of 38

HSBC Bank Oman SAOG

Key Financials (OMR mn) 2017 2018 2019 2020e 2021e 2022e Income Statement Interest Income 63.4 70.5 76.8 79.0 80.0 84.2 Interest Expense (9.1) (10.4) (16.2) (16.7) (17.0) (17.7) Net Interest/Financing Income 54.3 60.1 60.5 62.2 62.9 66.5 Fee & Commission Income 11.7 11.7 11.0 14.0 18.0 24.5 Other Income 9.4 14.1 15.1 12.8 9.1 4.1 Total Non-Interest/Financing Income 21.0 25.8 26.1 26.8 27.2 28.6

Total Operating Income 75.3 85.9 86.6 89.1 90.1 95.1 Operating Expenses (48) (49) (48) (49) (50) (52) Operating Profit Provisions expense (5.5) 1.5 (3.4) (13.2) (11.4) (9.6) Profit Before Taxation 21.4 38.0 34.7 26.4 29.2 33.7 Taxation (2.3) (6.6) (5.4) (4.8) (5.3) (6.1) Net Profit 19.1 31.4 29.3 21.7 23.9 27.6 Interest on Tier 1 Perpetual Securities - Net Profit Attributable to shareholders 19.1 31.4 29.3 21.7 23.9 27.6 Balance Sheet Cash Balances 224 271 281 265 256 246 Deposits with Banks & FIs 40 133 206 208 218 231 Net Loans 1,395 1,390 1,503 1,517 1,592 1,687 Investments 615 501 488 493 517 548 Net Fixed Assets 26 26 24 25 25 25 Other Assets 34 41 49 49 52 55 Total Assets 2,334 2,361 2,550 2,557 2,660 2,791

Deposits from Banks & FIs 36 38 55 55 57 60 Total Customer Deposits 1,932 1,926 2,071 2,077 2,165 2,278 Other Borrowings ------Other Liabilities 43 56 72 65 67 71 Total liabilities 2,011 2,020 2,198 2,196 2,289 2,409

Paid-up Capital 200 200 200 200 200 200 Retained Earnings 86 98 105 112 119 128 Other Reserves 38 43 47 49 51 54 Shareholders' Equity 323 340 352 361 370 382 Tier 1 Perpetual Notes ------Total Equity & Liabilities 2,334 2,361 2,550 2,557 2,660 2,791 Cash Flow Statement Cash from operations 150 (53) 13 3 29 37 Cash from investing activities 202 (114) (15) 6 24 30 Cash from financing (10) (14) (18) (13) (14) (16) Net changes in cash (61) 47 11 (16) (9) (10) Cash at the end of period 224 271 281 265 256 246 Key Ratios Return on Average Assets 0.8% 1.3% 1.2% 0.8% 0.9% 1.0% Return on Average Equity 6.0% 9.5% 8.5% 6.1% 6.5% 7.3% Net Interest Income / Operating Income 72.1% 69.9% 69.9% 69.9% 69.9% 69.9% Other operating income / Operating Income 27.9% 30.1% 30.1% 30.1% 30.1% 30.1% Net fee Income/Operating Income 15.5% 13.6% 12.7% 15.7% 20.0% 25.8% Interest Earning Yield 3.20% 3.46% 3.64% 3.58% 3.52% 3.51% Cost of Funds 0.47% 0.53% 0.79% 0.79% 0.78% 0.78% Net Spread 2.73% 2.93% 2.84% 2.79% 2.74% 2.74% Cost to Income Ratio 64.2% 57.5% 56.0% 55.5% 55.0% 54.5% Net Loans to Customer Deposits (Total LTD) 72.2% 72.1% 72.5% 73.0% 73.5% 74.0% NPLs to Gross Loans 3.8% 4.3% 4.5% 4.8% 4.9% 4.9% NPL Coverage, % 126.6% 118.1% 114.1% 107.3% 107.2% 107.1% Cost of Risk, bps 27.9 (7.4) 16.2 60.0 50.0 40.0 Shareholders' Equity to Total Loans, x 0.22 0.23 0.22 0.23 0.22 0.21 Shareholders' Equity to Total Assets, x 0.14 0.14 0.14 0.14 0.14 0.14 Capital Adequacy Ratio, % 16.9% 19.4% 18.8% 19.1% 18.7% 18.1% EPS, OMR 0.010 0.016 0.015 0.011 0.012 0.014 BVPS, OMR 0.162 0.170 0.176 0.180 0.185 0.191 Market Price, OMR* 0.128 0.119 0.121 0.094 0.094 0.094 Cash Dividend Payout Ratio, % 59.6% 59.3% 59.4% 59.4% 59.4% 59.4% Cash Dividend Yield, % 4.5% 7.8% 7.2% 6.8% 7.6% 8.7% P/E Ratio, x 13.4 7.6 8.3 8.7 7.9 6.8 P/BV Ratio , x 0.8 0.7 0.7 0.5 0.5 0.5 *Market price for current year and subsequent years as per the closing price on 05-May-2020 Source: Company Financials, U Capital Research

Page 37 of 38

Recommendation

BUY Greater than 20% ACCUMULATE Between +10% and +20%

HOLD Between +10% and -10% REDUCE Between -10% and -20% SELL Lower than -20%

Ubhar Capital SAOC (U Capital)

Website: www.u-capital.net PO Box 1137 PC 111, Sultanate of Oman Tel: +968 2494 9000 Fax: +968 2494 9099 Email: [email protected]

Disclaimer: This report has been prepared by Ubhar Capital (U Capital) Research, and is provided for information purposes only. Under no circumstances is it to be used or considered as an offer to sell or solicitation of any offer to buy. While all reasonable care has been taken to ensure that the information contained therein is not untrue or misleading at the time of publication, we make no representation as to its accuracy or completeness and it should not be relied upon as such. The company accepts no responsibility whatsoever for any direct or indirect consequential loss arising from any use of this report or its contents. All opinions and estimates included in this document constitute U Capital Research team’s judgment as at the date of production of this report, and are subject to change without notice. This report may not be reproduced, distributed or published by any recipient for any other purpose.

Page 38 of 38 P.O.BOX 1137, PC 111 – CPO, Sultanate of Oman l CR No. 1279406 l Tel: +968 2494 9000 l Fax: +968 2494 9099 l Email: [email protected] l Web: www.u-capital.net