• Bank Muscat’s deep discount to BV is unjustified Omani bank stock prices are down 8% in the past 3 months, driving valuations to multi-year lows. Bank Muscat in particular stands out as the most inexpensive stock in our Oman and MENA banks coverage, trading at a 2016e P/E of 7.0x and P/BV of 0.7x compared to MENA bank avg 2016e P/E of 8.8x and P/BV of 1.2x. We believe its 30% discount to BV is unjustified for Oman’s dominant deposit franchise. The bank is well capitalised, has strong balance sheet liquidity, low exposure to the construction segment, and the highest breakeven cost of risk (421bps) amongst Omani banks.
• Loan restructuring, asset quality deterioration to drive credit costs We expect corporates to approach banks for restructuring as the weakening economy and slower payment cycle weighs on cash flows. Recent regulatory changes on provisioning require banks to provide a 15% provisioning charge on restructuring of loans. In the short term, we expect restructuring-driven provisioning to drive up credit costs. However, should the restructured loans continue to perform as per the revised terms, banks should see reversals of provisioning costs in 2017. Over the medium term, asset quality is also likely to deteriorate, which should drive a second leg of provisioning in 2H2016-17. The contracting segment in particular poses a key asset quality risk in our view. Bank Muscat has the lowest exposure while Bank Dhofar has the highest exposure to the segment.
• Falling balance sheet liquidity levels to put pressure on margins Liquidity contracted sharply in 2015, with aggregate deposits for the sector growing only 2% Y-o-Y. Loan growth outpaced deposit growth, with the sector loans-to-deposit ratio rising by c1000 bps since end-2Q2015. Deposit rates have already started rising, with smaller banks in particular looking to raise deposits aggressively. We expect rising funding costs to pressure net interest spreads across the sector, and forecast a 10bps Y-o-Y compression in 2016. Banks have started pushing loan pricing higher, which should partially mitigate the pressure from rising funding costs, in our view.
• Stringent capital requirements will weigh on growth, profitability The central bank will maintain the current minimum CAR requirement of 12.625% until the end of 2016. However, the central bank envisages an increase in minimum CAR to 14.5% by the end of 2019, the highest in the region. The stringent capital requirements are likely to constrain the ability of banks to grow loans, and is likely to weigh on the profitability of the sector. NBO and Bank Muscat appear comfortably placed in terms of rising capital requirements, while Bank Sohar is likely to look at further capital raising options, in our view.

Murad Ansari