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 Page 1 of 38 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 Page 2 of 38 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%. Page 3 of 38 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