Diamond Bank Lowered To 'B-/C' On Reduced Earnings and Rising FX Liquidity Risk

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Friday, June 24, 2016 9:00AM /S & P Global Ratings

        Diamond Bank has a tight capital position and faces heightened foreign currency liquidity risks due to a lack of access to dependable sources of foreign currency funds.

         Earnings stability is vulnerable to the economic headwinds in Nigeria and pressure on the Nigerian naira.

         As a result, we are lowering our global scale ratings on Diamond to 'B-/C' from 'B/B' and our national scale ratings to 'ngBB/ngB' from 'ngBBB-/ngA-3'. We are subsequently placing the long-term ratings on CreditWatch negative.

         The CreditWatch placement reflects our concerns about the proximity of Diamond's capital adequacy to the regulatory minimum, as well as the bank's sizable foreign currency contractual liquidity mismatch, given that dependable sources of foreign currency funds are either limited or uncertain in the near term.


S&P Global Ratings today lowered its long- and short-term counterparty credit ratings on Nigeria-based Diamond Bank PLC to 'B-/C' from 'B/B'. We placed the long-term rating on CreditWatch with negative implications.

Similarly, we lowered our long- and short-term Nigeria national scale ratings on the bank to 'ngBB/ngB' from 'ngBBB-/ngA-3' and placed the long-term national scale rating on CreditWatch negative.

Diamond operates in the middle tier of a highly competitive banking sector, which is facing heightened economic headwinds underscored by oil production and price shocks, slowing economic growth, persistent foreign currency shortages, and depreciation risks.

The bank has a leading franchise position in retail and small business banking in Nigeria. This segment has helped Diamond acquire new customers, increase transaction volumes, especially through electronic channels, and sustain funding costs at around 3%--one of the lowest in the sector. However, this has not translated into advantages in extending loans to top-quality corporates in Nigeria, compared with its top-tier peers with similar funding costs.

At year-end 2015, Diamond reported a sharp 37% rise in nonperforming loans  (NPLs) to 7.1%, and a 96% increase in the cost of risk to 6.7%, compared with  a peers' average of about 6.0% and 3.0%, respectively. These increases resulted in low profitability overall and demonstrate the sensitivity of the bank's assets to the downturn in the economic cycle in Nigeria. We think Diamond's asset quality and earnings stability is vulnerable to further contraction in Nigeria's economy over the next 12 months, especially given itsbalance sheet concentrations, including:

·         Sizable sectoral concentration on oil and gas (31% of total loans and 12% of NPLs), most of which has been restructured over the past 12 months by extending the tenor of loans;

·         Exposure to other cyclical sectors, such as general commerce, manufacturing, and real estate and construction, which together accounted for 40% of total loans and 62% of NPLs as of March 31, 2016; and

·         Single-obligor and foreign currency lending concentrations, where the top-20 loans accounted for about 35% of total loans and one-half of the NPLs at year-end 2015; while approximately 50% of loans were denominated in foreign currency.

We anticipate that the bank's loss experience will remain a challenge for internal capital generation in 2016 and that the bank will likely sustain a weak risk-adjusted capital (RAC) ratio, according to our own RAC framework, in the 4.0%-5.0% range, from 5.6% at year-end 2015. Positively, the bank has sustained good loan recovery collections and maintained provision coverage over NPLs between 90%-100%, compared with a peers' average of about 65%.

We think that Diamond's regulatory capital adequacy ratio of 16.2% on March 31, 2016, offers only a thin buffer above the 15.0% statutory minimum, with  which to absorb any unexpected losses or accommodate a significant devaluationin the domestic currency (given the high concentration of foreign currency-denominated assets, some of which are unhedged). Consequently, we consider Diamond's capital adequacy could be at risk of regulatory forbearance.

In addition, we consider that the bank's contractual liquidity mismatch, particularly in foreign currency, is a rising risk, given the acute foreign currency liquidity shortages prevailing in Nigeria. At year-end 2015, approximately 20% of Diamond's deposits were denominated in foreign currency, and although its deposit base has generally exhibited stability over the past few years, it is contractually short tenored and could become confidence sensitive, which may lead to liquidity strain. Similar to peers, we think the bank's access to foreign currency and ability to refinance its existing U.S. dollar-based liabilities will be constrained in the current environment.

Although Diamond's business and financial performance over the next 12 months depends on favorable economic conditions in Nigeria, our base-case assumptions do not include a significantly higher probability of default such that we would apply our criteria for rating issuers at 'CCC'. However, we would consider a scenario in which this could happen if the bank's access to foreign currency liquidity becomes less certain, confidence risks heighten, or compliance with regulatory capital adequacy becomes a challenge.

We aim to resolve the CreditWatch within the next 90 days, during which time we will assess the possible impact that the changes in Nigeria's newly-adopted flexible exchange rate regime has on Diamond's ability to access foreign currency liquidity in the short term and on longer-term economic prospects in Nigeria. We will also take into account the impact that the currency's effective devaluation will have on Diamond's capital adequacy.

We could lower the ratings if the following were to materialize:

·         Diamond's regulatory capital adequacy ratio fell below the statutory minimum of 15% over the next 12 months, with no prospect of additional capital injection, debt conversion into equity, or asset sales in the short-term; and the regulator took action to restrict the bank's operations as a consequence; and

·         Diamond experienced liquidity strain in the form of foreign currency deposit calls or if it were less able to meet any other foreign currency obligations on time and in full, owing to limited access to foreign currency funds.

Over the next 12 months, we see limited upside to the ratings, due to the negative economic trends weighing on the bank's business and financial performance. However, we could affirm the ratings if:

·         The bank's asset quality metrics do not deteriorate beyond our current expectations;

·         The bank's capital and earnings buffers recover and the impact of the currency's devaluation on the balance sheet is muted, thereby providing ample headroom above its regulatory minimum and allowing the bank to sustain a RAC ratio above 3%; and

·         Foreign currency refinancing and liquidity challenges were to abate due to the liberalization of the domestic currency's exchange rate.

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