• Merger in progress; swap ratio to act as an anchor for the stock price Bank Dhofar and Bank Sohar announced a merger agreement on 8 June between the two banks. According to the merger terms, every one share of Bank Dhofar will be exchanged for 1.29 shares of Bank Sohar. The swap ratio links Bank Sohar’s stock price to Bank Dhofar’s stock price, and should act as an anchor for Bank Sohar’s stock price, in our view. At current market prices, this translates in to a price of OMR0.183/share for Bank Sohar. On a standalone basis, Bank Sohar’s valuations – 2016e P/E of 15.5x and PBV of 1.1x - appear demanding relative to peers, in our view. While our DECF value of OMR0.136 (adjusted for the 10% stock dividend) is much lower than the current price, we believe that the merger swap ratio is likely to remain a key determinant of the stock price. We raise our fair value to OMR0.17, assigning a 25% merger premium to our fair value.
• Profitability hit by weakening spreads and rising credit costs While Bank Sohar’s earnings recovered strongly from 1Q16, overall profitability levels remain weak. Annualised ROAE of 7.1% in 2Q16 is well below the cost of capital, and has been dented by a sharp compression in net interest spreads and rise in credit costs. The strong loan growth push has led to a tightening of balance sheet liquidity, which has raised funding costs sharply. Since the end of 2015, we estimate its net interest spreads have contracted 48bps. Furthermore asset quality has quality has deteriorated, with NPL ratio rising c17bps Q-o-Q to 1.6% in 2Q16.
• Capital buffers have been raised through Tier II issues The strong loan growth has also put pressure on the bank’s capital levels, with growth in RWAs offsetting the capital raising through the rights issue in 2Q15. The bank raised OMR27.5mn through a Tier II debt issue in 2Q16, and recently completed another Tier II debt offering of OMR35mn. We estimate that the recent Tier II issue should add c140bps to the bank’s total CAR, raising it to c15.7%.

Murad Ansari