Following conservatism in the first quarter, credit off-take in Omani banking sector is set to rise in the later part of this year thanks to strong government spending and active tendering activities, said a report.

According to Oman Arab Bank's report – Oman Banking Sector, a credit growth of 10 per cent is expected for the country's 2010 fiscal year.

"We believe diminishing interest rates will still induce banks to expand deposit base to feed long-term credit growth. Thus, we have assumed 15 per cent deposit [including CDs] growth for 2010 financial year," said Gunjan Gupta, head of research at Oman Arab Bank in the report.

However, the analyst remains cautious about the local loan portfolios as the listed banks in Oman have exponentially grown their relatively riskier retail loan book. Thus the report expects the non-performing loans/gross loan (NPL/GL) ratio to remain at 2009 financial year levels of 4.63 per cent in 2010 as well.

Outlook

During the financial crisis, the Central Bank of Oman's (CBO) strong and proactive regulatory framework helped Omani banks to sail through the difficult times.

"We believe the nascent stage of real estate and prudent banking strategy have placed Oman economy and banking sector in a relatively better position in comparison to other GCC countries," said the report.

Due to prompt disclosures of cross-border exposures to Saudi conglomerate, domestic banks were able to regain regional and foreign investors' confidence. Moreover, by fully providing for Saudi exposures, Omani banks now have a strong and clean balance sheet. However, the analyst believes that there are host of factors that will influence the banking sector performance.

Conservatism to vanish

The lower lending ratio, averaging around 80 per cent for all listed banks in the first quarter of 2010, and strong average capital adequacy ratio of around 15 per cent, which is higher than the regulatory requirement of 10 per cent, still gives enough scope of credit growth.

"Considering the fact that credit growth in the first quarter of this year has been modest, we still believe that despite encouraging macro indicators, banks will remain in cautious mode in the first half and will continue to concentrate on loan quality, which will limit the overall credit growth," said the report.

The smaller asset base of Omani banks leads to high reliance on foreign bank participation essential for successful financial closure of larger syndications in the country. The analyst believes as confidence in the inter-bank markets has taken a beating, access to syndicated loans will take longer to resume. This will further curtail corporate loan growth in near term.

"We envisage latter part of FY10 will witness improved credit off-take as banks will become less conservative. Thus we have conservatively assumed 10 per cent year-on-year consolidated credit growth for 2010 financial year. In 2011 financial year, we expect loan book will grow in a healthier way as banks will reduce risk aversion," said the analyst in report.

Corporate loan revival

With revival of economy and consumer confidence, Oman Arab Bank's analysts assume that corporates will come out of their cost-cutting mode, which will result in rise in working capital requirement. Additionally, considering the lower interest rate regime, corporates will revisit and revaluate their on-hold expansion plans, which increase the probability of opening more credit-lines. This makes analysts bullish on corporate side demand factors, the report pointed out.

Buoyant micro dynamics

Recovering oil prices created room for higher spending than envisaged in the budget. Even during the global economic turmoil, Oman's government continued its spending spree to stimulate the local economy, which is essential for turnaround. Thus actual total investment expenditure for the full year 2009 at RO2.36 billion (Dh22.5bn) is 23.4 per cent higher to the budgeted figures. For 2010, budgeted investment expenditure will increase by 11 per cent year-on-year to RO2.12bn.

Taking cue from 2009 continuous fiscal spending and oil price recovery, analysts are optimistic about infrastructure spending. "We believe more exploration activities planned for the year and the government's consistent investment expenditure will gradually translate into higher credit off-take in the latter part of 2010 financial year," said the report.

As per tender board announcements, total tenders awarded in the first quarter is RO500 million, which is 71.4 per cent higher compared to same period last year. "We expect although with a lag impact the series of new tender announcements in the second half of 2009 and this year, together with the government's intention to increase oil & gas production, will translate into sustained capital expenditure, which will instigate loan book growth," pointed out the report. Moreover, as projects become more viable in declining inflation scenario, it should boost overall investments in the economy."

Taking benefit of lower interest rates, banks strategically increased deposit base, thereby at consolidated level in the first quarter of 2010 overall deposits at RO 9.8bn, a rise of 7.7 per cent quarter on quarter. It constituted 65.8 per cent of total liabilities, as compared to the average of 63 per cent in the first quarter of 2009 and 64 per cent in the fourth quarter of the same year. Owing to deposit base expansion, loan-to-deposit ratio of the banks at system level improved from 109.3 per cent in the first quarter of 2009 to 108.2 per cent in the fourth quarter of the same year and further to 102 per cent in the first quarter of this year.

Major contributor to increasing provisioning and NPLs in 2009 was the exposure of Omani Banks to Saad Al Gosaibi, consequently NPLs reached its record level in June 2009. Banks took full provisioning against the Saudi exposures at the end of the year, resulting in a 15.2 per cent drop in net profits to RO198m in the financial year 2009.

Prudent increase in provisioning dampened 2009 profitability. Moreover, slower pace of recovery of project financing activities and the lag impact of announced tenders, together with non-active IPO market, resulted in 5.5 per cent year-on-year plunge in fees and commission income of all listed banks last year. But on the brighter side due to gradual recovery of equity markets, there was a significant fall of 58 per cent year on year to RO2.3m in impairment on available for sale investments of all listed banks.

The average capital adequacy ratio (CAR) of all listed banks in 2009 financial year stood at 15.57 per cent, compared to the minimum regulatory requirement of 10 per cent. Since Bank Muscat and Ahli Bank's CAR is undisclosed in the first quarter 2010, thus peer average will not be truly comparable. Still other banks are fairly above the stipulated limit of CAR.

The overall quality of capital of the banking system is good with no hybrid instruments. Even after upside revision of CAR to 12 per cent – which is effective from December 2010, the analysts are bullish about Omani listed banks as CAR for all of them currently is above 12 per cent, said the report.

TOP PICKS

Bank Muscat

Bank Muscat is top pick as its net profit in 2010 will grow the maximum among local peers by 63 per cent on the back of cleaner balance sheet from regional exposures. Moreover, analysts believe that Bank Muscat is better placed to benefit from the uptick in infrastructure development activities in the medium-term. On a relative basis among local peers, with a FY 2010 RoE of 15.8 per cent (vs. 13 per cent) and P/BV of 1.31x (vs. 1.7x), Bank Muscat seems to be a better contender. We thus reiterate our target price at RO1.12 per share (upside of 42.8 per cent) and maintain "buy" rating on Bank Muscat.

NBO: Buy

Although the study believes that the benefit of reduction in overall interest rates and lower dependency on costlier time deposits will improve spreads by 14bps to 3.5 per cent in 2010. But the analysts remain cautious on deteriorating domestic asset quality which will keep credit growth subdued. However, NBO continues to remain a valuation play. At FY10 P/BV multiple of 1.33x, NBO is relatively cheaper compared to domestic industry average of 1.7x, thereby making it a compelling "buy". Based on revised earnings estimates due to absence of regional exposure, it raised target price from RO0.402, with upside potential of 21.3 per cent.

Ahli Bank: Buy

Even though Ahli Bank's 2010 financial year P/BV of 1.84x, is slightly higher compared to domestic industry average of 1.7x but the stock offers the highest credit growth, thus upgraded it from "hold" to "buy". "Based on revised earnings estimate, we give a target price of RO 0.299, " said the report.

Bank Sohar: Buy

Similar to Ahli Bank, FY10 P/BV multiple for Bank Sohar at 1.8x is close to local banking sector average of 1.7x. The analyst believes that Bank Sohar is a long-term story and being in expansion phase has higher potential for balance sheet growth, thus initiated Bank Sohar with a "buy" rating and a target price of RO 0.276 (30.7 per cent upside potential).

Bank Dhofar: Sell

Bank Dhofar's corporate portfolio is well diversified and less risky, which further increases its scope to expand corporate loan book as infrastructure spending trickles down to various sectors. But based on FY10 P/BV multiple at 2.7x Bank Dhofar is expensive amongst local peers, thereby making it less attractive. Moreover, the stock has already moved upwards and adjusted for higher growth expectation and thus based on target price of RO 0.606 per share (downside of 20.3 per cent) analysts downgraded rating from "hold" to "sell".