17/11/2018/By ARM Research
Last week, global rating agency S&P lowered its issuer rating of Diamond Bank by one notch to CCC+ from B- majorly due to two concerns. Firstly, the rating agency expressed concerns on the possibility of higher provisioning which will put pressure on the bank’s capitalization.
Furthermore, S&P believes the bank’s foreign-currency liquidity position remains vulnerable largely due to its maturing Eurobond in May 2019. The impact of this downgrade saw investors sell-off the bank’s Eurobond with yields spiraling to over 30% (+1500bps MTD).
The rating downgrade also comes after a corporate governance racket which saw the resignation of four non-executive directors – including the Chairman – without concrete reasons. However, market feelers suggest the development was related to the difference among the board on recapitalization plans.
Source: ARM Research /NSE
Information suggest that the bank was in the process of either accepting capital injection from a major shareholder or being taken over by a bigger bank, who aims to leverage on Diamond bank to penetrate the retail market for cheap deposit.
While this news has been canned by Diamond Bank, the saying that there is no smoke without a fire now keeps us on the observer mode, awaiting the end of the twist.
Eurobond redemption…any cause for concern?
Diamond Bank is faced with $200 million maturity of its Eurobond in May 2019. Based on recent engagement with management, the bank plans to fully redeem the bond as against refinancing. Management expects to redeem the bond via proceeds of the sale of the UK business, repayments of FCY loans (45% of total loans) and FX flows from bilateral agreements. As at FY 2017, Diamond bank had a net-long FCY position of $95 million while S&P suggest the bank has $70 million set aside for repayment of maturing Eurobond.
The balance is expected to come from the proceeds of the sale of UK business. In trying to estimate the expected proceeds, we use average P/B of comparable banks listed in the UK (0.98x) with the book value of Diamond Bank UK ($156 million), which brings expected market value of $153 million. Hence, we believe Diamond Bank is in a fair position to redeem its maturing Eurobond.
We see bargain opportunity in buying into the Eurobond now following the sell-off which has seen yields spiked to over 30%, as we believe the recent selloff is largely driven by the downgrade in ratings, which has now put the bond below minimum investment criteria for institutional funds.
Table 2: Yields of Comparable Eurobonds with similar Credit Rating
Recapitalization or License Conversion?
Diamond bank’s capital adequacy ratio (CAR) currently stands at 16.3%, largely supported by the sale of Diamond Bank S.A(It’s West African business operation. Without the sale, CAR would have printed at 15.6%). Earlier in 2016, the bank almost saw its CAR fall below the minimum regulatory requirement, printing at 15.01%. Going forward, we expect higher provisioning to put pressure on the bank’s CAR.
Specifically, factoring our expectation of higher provisioning over Q4 18 (N21.0 billion), we believe the bank’s CAR could fall to 15.0% – 15.5%. Consequently, Diamond Bank may struggle to maintain a regulatory requirement for banks with international operations (CAR of 15%). Thus, we expect the bank to either recapitalize or convert its license to a national banking license from international banking license following the sale of its UK business.
Diamond bank has already received an offer of capital injection from a major shareholder. We believe the shareholder is Carlyle Group who currently owns about 18% stake in Diamond bank. Additional capital from Carlyle Group could see them having more control in the bank. Also, another option for the bank is to be acquired by a larger bank with potential synergy benefits.
However, this option looks less likely as we expect some kick-backs by selected key shareholders. Irrespective, we are of the view that the bank will switch from its international banking license to a national banking license, post completion of UK divestment. This would bring regulatory capital requirement down to 10% from 15%. Thus, we expect an ease to capital adequacy issue in the coming period.
Overall, we are of the view that the pending concerns on Eurobond repayment and Recapitalization will be short-lived as our analysis suggest no cause for alarm. However, we are still negative on profitability with our FY 2018 estimate, translating to a loss after tax of N2.6 billion (compared to a loss of N12.9 billion in 2017) on the back of funding cost pressure.
Following a massive sell-off over the past few days (-32% MTD), current price (N0.95) of the stock now translates to a BUY rating given our FVE of N1.39.
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