By Dipo Olowookere

Following the announcement of a proposed merger between Diamond Bank and Access Bank, renowned rating agency, Fitch Ratings, has placed both Nigerian lenders on its rating watch.

In a statement issued by Fitch, it said Diamond Bank’s Long-Term Issuer Default Rating (IDR) has now been downgraded 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 also simultaneously placed Access Bank Plc on Rating Watch Negative (RWN).

It explained that the downgrade of Diamond Bank’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.

Fitch noted that 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 said it believes that the probability of the completion of the merger is sufficiently high to take rating action.

The RWE on Diamond Bank 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 the view that should Diamond Bank 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 Bank will cease to exist as a separate legal entity, and Fitch 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 $200 million Eurobond maturing in May 2019, $100 million from Afrexim due in March 2019, and $70 million from the International Finance Corporation due in July 2019.

Fitch said it also understands that some large long-term obligations have recently become current suggesting intensified liquidity pressure.

According to Diamond Bank’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 said it also understands that Access Bank may provide some liquidity support to Diamond Bank, although it will not assume a direct liability for Diamond Bank’s debt payments pre-merger.

Fitch point out that Access Bank withdrawing from the deal would most likely be negative for Diamond Bank.

It said the RWN on Access Bank’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 Bank’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 Bank’s stage 3 loans stood at 37 percent of gross loans at end-1H18. Additionally, the bank’s stage 2 loans stood at 23 percent of gross loans at end-1H18, indicating the extent of its weak asset quality.

Access Bank has better asset quality with stage 3 loans and stage 2 loans accounting for 5 percent and 14 percent of gross loans, respectively, at end-1H18.

Diamond Bank plans to take LICs of between N150 billion-N180 billion before writing off bad loans by end-2018. Diamond Bank’s total equity was N222 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, Fitch said it understands that as per the central bank’s IFRS 9 transition guidelines, Diamond Bank 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 percent minimum regulatory requirement.

Access Bank estimates that its CAR should stand at around 20 percent (above its minimum regulatory capital requirement of 15 percent) post-merger, which will be helped by the expected $250 million Tier 2 capital issuance in January 2019 and strong retained earnings.

Fitch explained that the banks’ National Ratings reflect their creditworthiness relative to Nigeria’s best credit and relative to peers operating in the country. Diamond Bank’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, it said.

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

Fitch said Diamond Bank’s senior unsecured debt rating has been downgraded to ‘CC’/’RR4’ from ‘CCC’/’RR4’, with the lender’s senior unsecured debt rating also placed on RWE, reflecting that on its Long-Term IDR. It stated that the Long-Term Ratings on Access Bank’s senior unsecured and subordinated debt have been placed on RWN, reflecting that on its Long-Term IDR.