Culled—Proshare

November 7, 2016/FBNQuest Research

Further downside likely from current levels
We expect the market to focus only on asset quality metrics for Diamond going forward, much more than in previous quarters, given the scale of the negative surprise in the bank’s Q3 2016 results.

Management has updated its asset quality metric guidance for 2016E, increasing both the NPL ratio and the cost of risk guidance by 150bps and 100bps respectively to 9% and 6% respectively. Implied in the guidance is a q/q improvement in the NPL ratio which is flattered by potential write-offs.

For Diamond to positively surprise, the most likely trigger would be a strengthening of the naira given that the recent devaluation has been the most significant factor impacting loan loss provisions via the oil and gas loan book. The probability of such a scenario playing out is extremely low in our view.

On the back of the Q3 results, we have reduced our 2016-17E earnings forecasts by an average of 40% and our price target by 46% to N0.9. Despite having shed -52% ytd (ASI: -6%), we now expect the shares to record further losses going forward, hence our decision to downgrade our recommendation to Underperform from Neutral.

Loan loss provisions led to losses in Q3
Diamond Bank’s Q3 2016 PBT came in at –N6.6bn vs a profit of N4.4bn a year earlier and our forecast of N4.6bn (PBT was N3.8bn in Q2 2016). Although the bank booked N2.4bn in other comprehensive income on the back of fx translation gains, this was not enough, leading to a loss after tax of –N3.2bn.

Asset quality deterioration was the main driver behind the weak results: loan loss provisions grew 230% y/y and by over 100% q/q to N21bn. The value of collateral backing oil and gas loans in particular had become insufficient, leading to a need to book additional provisions. Of the two revenue lines, net interest income grew 7% to N28bn while non-interest income grew much faster, by 51% y/y to N11bn.

We should add that the non-interest income result was weaker than we were expecting, despite the strong growth delivered (Q2 had come in strong; the q/q change in Q3 was a -10% decline).

In contrast, net interest income was slightly (3%) better than our forecast and improved 15% q/q. We suspect this was largely fx-driven (devaluation impact on FCY loans). Although opex grew 8% y/y and surprised negatively (by 4%), the impact was significantly muted compared with that of loan loss provisions.