December 24, 2018/Fitch Ratings

Fitch Ratings has downgraded Diamond Bank Plc’s (Diamond) Long-Term Issuer Default Rating (IDR) to ‘CC’ from ‘CCC’ and Viability Rating (VR) to ‘cc’ from ‘ccc’ and placed its IDRs and VR on Rating Watch Evolving (RWE). The agency has simultaneously placed Access Bank Plc (Access) on Rating Watch Negative (RWN). A full list of rating actions is at the end of this commentary.

The downgrade of Diamond’s ratings reflects the deterioration in the bank’s foreign-currency (FC) liquidity position since the last review and an expected deterioration in the bank’s capital position following additional loan impairment charges (LICs) on the announced write-offs of stage 3 loans under IFRS 9, to take place by year-end.

The Rating Watches (RW) follows a memorandum of agreement between the banks to merge. The merger is expected to be completed by end-June 2019. Although the agreement is subject to regulatory and shareholder approval, Fitch believes that the probability of the completion of the merger is sufficiently high to take rating action.

KEY RATING DRIVERS
IDRS and VR
The RWE on Diamond reflects Fitch’s view that its standalone creditworthiness could improve or deteriorate beyond the current ratings, depending on the realisation of the merger and the bank’s ability to meet its upcoming FC obligations prior to it.

The upside aspect of the RWE reflects Fitch’s view that should Diamond meet its near-term obligations and the merger be completed, it is likely to be positive for the bank’s creditors due to the stronger franchise and financial metrics of the combined entity. Following completion of the merger, Diamond will cease to exist as a separate legal entity, and we will then withdraw its ratings.

However, the downside aspect of the RWE reflects significant risk with regards to the bank’s near-term FC liquidity position given its large short-term bullet repayments, including a USD200 million Eurobond maturing in May 2019, USD100 million from Afrexim due in March 2019, and USD70 million from the International Finance Corporation due in July 2019. Fitch also understands that some large long-term obligations have recently become current suggesting intensified liquidity pressure.

According to Diamond’s FC liquidity plan, the bank should be able to meet its obligations using existing US dollar liquidity, proceeds from the sale of its UK subsidiary, cash flows from maturing US dollar loans (mainly from oil and gas loans), and by exchanging naira into US dollars through the interbank market. However, the plan is based on a number of assumptions, including the completion of the sale of the UK subsidiary, which has not yet been approved by the Prudential Regulation Authority in the UK, and therefore liquidity remains tight and highly vulnerable.
Fitch also understands that Access may provide some liquidity support to Diamond, although it will not assume a direct liability for Diamond’s debt payments pre-merger. Access withdrawing from the deal would most likely be negative for Diamond.

The RWN on Access’s Long-Term IDR of ‘B’ and VR reflects the potentially negative impact on its financial metrics from the absorption of a weaker bank and execution risks post-merger. Upon completion of the merger Fitch will assess the bank’s credit profile. A potential downgrade is likely to be limited to one notch. However, it is also possible that Access’s ratings could be affirmed with a Stable Outlook if the impact from merger appears to be more moderate, given the bank’s currently sound financial metrics and the planned capital raising, and provided there are no additional unforeseen risks emerging from Diamond.

Diamond’s stage 3 loans stood at 37% of gross loans at end-1H18. Additionally, the bank’s stage 2 loans stood at 23% of gross loans at end-1H18, indicating the extent of its weak asset quality. Access has better asset quality with stage 3 loans and stage 2 loans accounting for 5% and 14% of gross loans, respectively, at end-1H18. Diamond plans to take LICs of between NGN150 billion-NGN180 billion before writing off bad loans by end-2018. Diamond’s total equity was NGN 222 billion at end-9M18, meaning that its capital position at end-December 2018 following the write-offs will be materially weaker.

For regulatory capital calculations, we understand that as per the central bank’s IFRS 9 transition guidelines, Diamond will be able to phase-in the impact of additional LICs on its total capital adequacy ratio (CAR) over a four-year period, allowing it to remain above its 10% minimum regulatory requirement.

Access estimates that its CAR should stand at around 20% (above its minimum regulatory capital requirement of 15%) post-merger. This will be helped by the expected USD250 million Tier 2 capital issuance in January 2019 and strong retained earnings.

NATIONAL RATINGS
The banks’ National Ratings reflect their creditworthiness relative to the country’s best credit and relative to peers operating in Nigeria. Diamond’s National Long- and Short-Term Ratings have been downgraded to ‘CCC’ and ‘C’, respectively, from ‘B’ and ‘B’, reflecting its weaker credit profile relative to peers.

Diamond’s National Ratings have also been placed on RWE based on our expectation that its assets and liabilities will be transferred to Access’s balance sheet, but also that its credit profile may deteriorate further relative to peers’ in the interim. The RWN on Access’s National Ratings indicates potential downside risks of the merger.

SENIOR AND SUBORDINATED DEBT
Diamond’s senior unsecured debt rating has been downgraded to ‘CC’/’RR4’ from ‘CCC’/’RR4’. Diamond’s senior unsecured debt rating has also been placed on RWE, reflecting that on its Long-Term IDR.

The Long-Term Ratings on Access’s senior unsecured and subordinated debt have been placed on RWN, reflecting that on its Long-Term IDR.

RATING SENSITIVITIES
IDRS, VR AND NATIONAL RATINGS
The ratings were placed on RW due to an ongoing situation which requires resolution, which may take place in more than six months.

Fitch expects to resolve the respective banks’ RW once the merger is completed and there is more clarity on the credit profile, integration and strategy/risk appetite performance prospects of the combined entity. At this point, we will take action on Diamond Bank’s ratings and simultaneously withdraw them, as the bank will cease to exist as a separate legal entity.

In the interim period, Fitch will also review Diamond’s RW should its liquidity position (especially in FC) significantly change, either positively or negatively, or should its solvency position deteriorate.

Post-merger, Access’s ratings could be downgraded if the bank’s financial profile, particularly its capitalisation, asset quality or FC liquidity deteriorates or in the medium term, if the bank’s risk appetite, strategy and/or business model changes direction. They could be affirmed if the impact from merger appears to be more moderate or upgraded in the medium term if Access’s financial profile becomes sustainably comparable with higher rated peers, such as Zenith Bank, Guaranty Trust Bank or United Bank for Africa.

The banks’ National Ratings also remain sensitive to a change in their creditworthiness relative to other Nigerian issuers.

SENIOR AND SUBORDINATED DEBT
A change in the banks’ IDRs would ultimately lead to a change in the ratings of their senior debt. A change in Access’s VR would lead to a change in the rating of its subordinated debt

The rating actions are as follows:

Diamond Bank
Long-Term IDR downgraded to ‘CC’ from ‘CCC’; placed on RWE
Short-Term IDR ‘C’; placed on RWE
Viability Rating downgraded to ‘cc’ from ‘ccc’; placed on RWE
Support Rating unaffected at ‘5’
Support Rating Floor unaffected at ‘No Floor’
National Long-Term Rating downgraded to ‘CCC(nga)’ from ‘B(nga)’; placed on RWE
National Short-Term Rating downgraded to ‘C(nga)’ from ‘B(nga)’; placed on RWE
Senior unsecured long-term rating downgraded to ‘CC’/’RR4’ from ‘CCC’/’RR4’; placed on RWE

Access Bank Plc
Long-Term IDR ‘B’; placed on RWN
Short-Term IDR affirmed at ‘B’;
Viability Rating ‘b’; placed on RWN
Support Rating unaffected at ‘5’
Support Rating Floor unaffected at ‘No Floor’
National Long-Term Rating ‘A+(nga)’; placed on RWN
National Short-Term Rating ‘F1(nga)’; placed on RWN
Senior unsecured long-term rating ‘B’/’RR4’; placed on RWN
Senior unsecured short-term rating affirmed at ‘B’
Subordinated long-term rating ‘B-‘/’RR5’: placed on RWN