Nigeria-based Access Bank PLC and Diamond Bank PLC have announced a merger, which we expect to close by June 2019, on receipt of regulatory approvals. We anticipate that the acquisition is unlikely to affect Access Bank’s credit profile, and will relieve some of the liquidity pressure on Diamond Bank.
We are affirming our ‘B/B’ long-term issuer credit ratings with a stable outlook and our ‘ngA/ngA-1’ Nigeria national scale ratings on Access Bank.
We are revising our outlook on Diamond Bank to stable from negative, and affirming the ‘CCC+/C’ issuer credit ratings. At the same time, we are raising our Nigeria national scale rating on Diamond Bank to ‘ngBB’ from ‘ngBB-‘.
S&P Global Ratings today affirmed its ‘B/B’ long- and short-term issuer credit ratings and ‘ngA/ngA-1’ Nigeria national scale ratings on Nigeria-based Access Bank PLC. The outlook remains stable.
At the same time, we revised our outlook on Diamond Bank PLC to stable from negative and affirmed the ‘CCC+/C’ issuer credit ratings. We raised our long-term Nigeria national scale rating on Diamond Bank to ‘ngBB’ from ‘ngBB-‘ and affirmed the short-term national scale rating at ‘ngB’.
On Dec. 21, 2018, Access Bank made a binding offer to acquire Diamond Bank. Under the memorandum of agreement, Access Bank will acquire all outstanding shares of Diamond bank in a cash and shares transaction. We expect the deal will likely close by the end of June 2019, and is conditional on receiving regulatory approvals. Upon closure of the deal, Diamond Bank will cease to exist as a separate legal entity.
We have affirmed our ratings on Access Bank at ‘B/B’ with a stable outlook, based on our view that potential short-term acquisition risks should be offset by Access Bank’s record of accomplishment in mergers and acquisitions. Access Bank has demonstrated its ability to successfully integrate the bank when it acquired Intercontinental Bank in 2011. Access Bank’s forensic approach mitigates the merger risks.
Over the medium term, we believe that the acquisition should help Access Bank strengthen its franchise and revenue generation capabilities. On Dec. 31, 2017, Diamond Bank had over 6.5 million retail customers with the retail business providing approximately 70% of deposits and 35% of revenues. Furthermore, Diamond Bank has established partnerships with several parties to enhance its digital banking offering. We think these strategies will accelerate Access Bank’s position in that space and increase retail transaction volumes. Diamond Bank’s retail focus enabled the bank to build a low-cost (2.7% in 2017 compared with 4.7% on average for peer banks) and stable retail deposit base.
We expect the merger of the two entities will likely boost earnings capacity, with return on equity increasing close to 20% by 2020. However, we expect about 40% of nonperforming loans (NPLs), including the past due not impaired (PDNI) loans, to be transferred to Access Bank upon the acquisition. We understand that Diamond Bank will write off a large portion of the problem loans by the time of the acquisition. As a result, we forecast that Access Bank’s NPLs ratio post merger will increase to 8% in 2019 before reducing to below 7% in 2020. Similarly, cost of risk will increase to 1.2% in 2019 as Access Bank will have to make additional Stage 2 loan impairment provisions to account for the PDNI, which largely relate to the oil and gas sector.
We expect credit losses to normalize thereafter to around 1%, reflecting the good credit quality of Access Bank’s loan portfolio, which comprises about 50% investment grade corporate clients. Access Bank’s asset quality metrics will compare adequately with top peers in Nigeria and regional peers, albeit at the lower end of the range.
We view the Nigerian banking sector as a risky operating environment (classified in Group ’10’, the highest-risk category under our Banking Industry Country Risk Assessment), with much higher credit losses anticipated for the sector, at around 3% for 2018.
Access Bank’s market position is set to transform moving into 2019, given Diamond Bank’s solid retail franchise. The combined entity will have total assets of about Nigerian naira (NGN) 5.9 trillion, representing a 19% total market share by total assets. Access Bank is planning to close about 80 branches, thus reducing the operating base of Diamond Bank by 30% upon the
merger. We forecast the cost-to-income ratio will remain high at about 60%, reflecting the integration of Diamond Bank. This ratio compares less favorably with the best performing banks in the sector.
More importantly, Access Bank will acquire Diamond Bank’s deposit franchise, which will support its business by lowering its cost of funding. We forecast the net interest margin will
increase significantly above 6% by 2019-2020, while fees and commissions will rise by NGN30 billion upon the merger. We expect both funding and liquidity metrics to show improvement at year-end 2019. We forecast our risk-adjusted capital (RAC) ratio to weaken to 3.5% in 2019 before strengthening above 4% on the back of stronger earnings capacity post merger in 2020.
We still believe that Diamond Bank’s creditworthiness remains dependent on favorable business, financial, and economic conditions to meet its financial obligations. We expect Diamond Bank to raise provisions for the large amount of PDNI–about NGN250 billion–as it completes the implementation of IFRS 9 in 2018. In addition, we understand that the bank will be in a position to write off about NGN100 billion that will be fully provided for upon the date of the merger. As a result, we expect our measure of Diamond Bank’s RAC to be weak at around 3% by the time of the merger.
In May 2019, Diamond Bank will have to repay its maturing Eurobond principal of $200 million. We understand that the bank has fully provisioned this amount. The bank is also in the process of selling its U.K. subsidiary. Recently, the Central Bank of Nigeria gave its approval to the bank to convert to a national banking license with a minimum 10% capital adequacy ratio, which has reduced the pressure on its regulatory capital, in our view. This has led us to revise our outlook to stable from negative and raise our long-term national scale rating to ‘ngBB’ from ‘ngBB-‘.
The stable outlook on Access Bank reflects our expectation that the transaction will likely boost the bank’s earnings capacity in the next 12 months, thus cementing its competitive position among top-tier banks in Nigeria. It also reflects our expectation that its positive track record in mergers and acquisitions, as well as its risk management framework, will mitigate operational and integration risks associated with the transaction.
However, we would lower the ratings on the bank if its asset quality were to deteriorate below our expectations for the sector average, due to quicker loan growth, leading to RAC weakening below 3%.
A positive rating action appears remote in the next 12 months, because it would hinge on an upgrade of Nigeria as well as an improvement in banking risks in Nigeria, while all other factors remain equal.
The stable outlook on Diamond Bank reflects our expectations that the bank will be in a position to repay its $200 million Eurobond in May 2019.
We would lower the rating in the unlikely event that the deal does not go through as we believe that the provisioning needs under IFRS 9 will likely be higher than anticipated, or if we were to see an increase in foreign currency liquidity risk.
A positive rating action is remote. However, we may consider raising the bank’s rating above ‘CCC+’ closer to the merger date.