· Diamond Bank (Diamond) reported gross earnings of N64.9 billion for 6 months ended June 2012; a 47% YoY growth. PBT and PAT came in at N15.4 billion and N10 billion respectively, seven-fold YoY increments from the provision-laden base period.
Rapid growth in risk assets boosts revenue
· Diamond’s balance sheet grew a further 12% in Q2 2012, bringing YTD growth to 19% largely reflecting a 17% QoQ growth in the loan book toN506 billion, which brings YTD loan growth to 49%. In light of relative stability in interest rates in Q2, we believe the balance sheet expansion was largely responsible for the growth in topline.
· Revenue increased 11% QoQ to N34 billion driven by both interest (+8%) and non-interest income (+22%). The moderate interest impact in face of strong risk asset growth appears a result of Diamond’s resurgent interest in the corporate space to maintain its dual focus alongside retail banking. Nevertheless, the retail business continues to play a key role in Diamond’s operations and management reports average monthly income has increased further to N700mn/month.
Benefits of retail platform still evident in funding costs but Opex confirms fears
· The larger portion of the funding for balance sheet expansion, nonetheless, came from deposits which grew 6% QoQ (+13%YTD) to N679 billion. In spite of this, funding costs remained unchanged at 2.7% implying that the N0.6bn increase in interest expense to N5.4bn was largely volume-driven.
· Diamond’s ability to maintain stable funding costs after the general industry uptick in Q1, as a fall out of increased competition, speaks to continued success with its retail liability-generation strategy. Its Saving Xtra product is at the forefront of the drive and management indicates the product has quadrupled its base to ~N90bn over the course of a year.
· After the dip in Q1, operating costs has again resumed an uptrend rising 16% QoQ to N15.7 billion. Although ‘personnel expenses’ climbed 18%, much of the jump was from ‘other expenses’ which nearly doubled to N5.8 bn, offsetting the 29% dip in ‘admin. expenses’. As a result, CIR deteriorated 140bps QoQ to 53%, which is nevertheless still a significant improvement from 66% average in 2011. The result confirms our fears that the dip in Q1 might not be sustained, a concern we based on inflationary pressures and plans to open 60 new branches in the course of the year.
Provisioning still high; Risk asset growth may pause in H2
· Diamond booked additional provisions of N5.5 billion in Q2 2012, 18% higher QoQ. We believe this continues to reflect the impact of sales to AMCON in Q4 2011 at poorer valuations as well as relatively low coverage ratios. This charge as well as higher opex costs was primarily responsible for PBT and PAT dipping 4% each QoQ, in spite of significant growth in profitability YoY.
· Diamond’s ability to grow risk assets was supported by ~$100mn Tier II capital it raised from multilateral agencies in Q2 12. Coming off the significant equity erosion in 2011, this was a key part of its strategy to support growth. However, the fresh capital has been maxed out with Diamond reporting CAR of 12% for the group—close to 10% regulatory limit, leaving little margin to sustain a similar pace of risk asset growth for H2 2012 without new capital infusion. Consequently, our revenue expectation have factored in a flat trajectory for revenue (FY 2012E: N130bn) from current levels which could moderate YoY growth to 35% by FY2012 as the base impact of the stronger revenues in H2 2011 also kick in. Although Diamond remains in negotiations to raise more dollar-based Tier II capital, we think the impact could take a while to materialize in light of delays with the latest tranche.
· Nevertheless, we remain positive on the potential of the retail business which is currently supporting the recovery in fee income based on high turnover. The retail business currently accounts for ~15% of bank assets with 50% exposure to SMEs, 15% to personal loans as well as a rapidly growing mortgage arm. However, we continue to expect the benefits will remain more visible on the liability side for which the retail business accounts for ~50% of the bank’s base. Considering evident success with gathering cheap deposits, we estimate funding costs will stay around current levels but expect actual interest expense (FY 2012E: N22bn) to rise in line with growing volumes.
· We envisage Diamond’s opex will stay elevated in line with inflationary pressures and efforts to broaden its footprint. We have estimated the current rate of growth will continue and estimate CIR of 55% for FY2012. We expect this scenario will persist over the medium term as plans by the retail business to open a further 100 normal-sized branches as from 2013 should continue to drive opex.
· Although we had envisaged significant provisioning will persist into H1 2012, reported levels are higher than we anticipated as our initial estimates of N17bn for the year is set to be exceeded at current run rate. Furthermore, NPL ratio has worsened a further 1pps to 7.6% from FY2011 and we expect this could drive further charges. Consequently, we have revised our estimates for provisions upwards to N19bn for FY 2012. We now expect benefit from risk management initiatives to be more evident from 2013 which in combination with renewed interest in the corporate space should help limit delinquencies going forward.
We maintain BUY rating on expected improvements in profitability
· Overall, having shown an ability to compete with Tier I banks in an area in which they hold a key advantage – funding costs – we remain positive on Diamond’s prospects especially as we believe the impact of its execution of the retail strategy could be more readily evident in Diamond’s performance compared to larger peers. Broadly, we expect the improvements in profitability to remain on track.
· Nonetheless, downward revisions to our profit estimates based on higher opex and provisions lines in the near term culminated in a lower fair value estimate of N6.40 from N7.2, previously. The significant upside this implies from current price of N2.41 underscores the additional pressure on the stock from recent poor performance, beyond broader industry concerns. The stock retains significantly attractive valuations trading on 0.4xBv compared to 0.9x for the industry. Based on the foregoing, we maintain a BUY rating on the stock.
ARM ratings and recommendations
ARM now employs a two-tier rating system which is based on systemic importance of the security under review and the deviation of our target price for the stock from current market price. We characterize systemic importance as a function of a stock’s ranking among the group of top 20 stocks by NSE market capitalization over a trailing 6 month period (minimum) to the review date. We adopt a 5 point rating system for this category of stocks and a 3 point rating system for stocks outside this group. The choice of top 20 stocks arises from the consideration that this group of stocks constitutes >75% of overall market capitalization and stocks outside this group are generally less liquid and individually account for <<1% of market capitalization. For stocks in both categories, the basis for ratings subject to target price deviation is outlined below: