July 19, 2012

SSA ex|Equity|Banks

BUY [Prev. BUY]

TP Ngn3.65 [Prev. Ngn3.65]

DIAMOND NL
The Beauty of Ugly Part 2: 1H12 pleasing; Consistency required to restore conviction
Reiterating our BUY; Maintaining our FY12 Price Target (PT) of Ngn3.65: We believe there is risk of potential deterioration/slower than expected improvements in asset quality and profitability, but at current valuation (Trailing PBVR of ~0.4x and PER of 1.8x) our concerns seem to be fully reflected. Relative to our Sub Sahara Africa ex South Africa (SSA ex) universe, the stock has moved into the cheap but value destroying banks quadrant. The stock trades at the lowest Price/Pre-Provision operating profit (PPOP) at 0.6x vs. 3x for our Nigerian universe. The forward PBVR is 0.3x vs. our Justified PBVR of 0.7x. Revising our key assumptions: 1) Loans/deposits ratio (LDR): We increase the LDR to 80% from 75% as we anticipate loan growth to outpace deposit growth; 2) Interest income/IEA: We revised the ratio upwards by 200bps to 13% to reflect the relatively high interest rate environment and the continued asset growth in the retail and SMEs segments; 3) fee income ratio: We reduce the ratio as we have witnessed slower growth in 1H12 than we expected; and 4) Provisions ratio: We reduce it to 4% from an initial 5%. We expect recovery process to be slow and the high level of doubtful debts could lead to higher coverage ratio for FY12. Our provision forecast is Ngn28.6bn vs. management guidance of Ngn20bn. (see Fig 1). Risk/reward profile seems to be out of sync: Despite the evidently high risks the return on assets (ROA) has been ordinary, at an average of 1.5% between FY05 and FY10. For the risks Diamond assumes, one would expect stronger ROAs. As we mentioned before, Diamond could be underpricing risks in order to gain market share. The relatively superior NIM (a result of asset mix) could come under pressure as the LDR increases and limit opportunities for further asset mix changes. However, given the muted competition in the space Diamond plays in, further pressure on spreads from the asset side are muted although deposit competition could increase the cost of funds. and profitability will demand PPOP to grow faster than provisions, which we are sceptical about despite the improvements: We note that PPOP growth is inferior to provision growth. Provisions CAGR between FY05 and FY11 is 93% vs. a 36% for PPOP. In our forecast, we grow PPOP faster than provisions, but the risk is that the provision growth could continue to outpace PPOP growth. (see Fig 2). The high level of doubtful loans (74% of NPLs) could lead to higher coverage ratio this year as the loans migrate to lost status.

CONSTRUCTIVE
Universe Recommendations
Code ACCESS NL DIAMOND NL FIRSTBAN NL GUARANTY NL UBA NL ZENITHBAN NL Current FY 12 Potential Action Price PT 7.7 2.4 12.17 17.4 4.6 15.23 8.7 3.7 13.7 17.4 6.0 16.9 13% 52% 13% 0% 31% 11% BUY BUY BUY HOLD BUY BUY

CAMEL ratios
C: Leverage A: Provisions/Loans A: Coverage ratio M: Cost/Income M: NII/Operating income E: NIM E: ROA E: Profit/Deposits E: ROE L: Loans/Deposits 2010 5.6 -3.8% 85.0% 62.8% 67.2% 11.6% 0.2% 0.3% 1.2% 71.4% 2011F 8.6 -5.5% 85.0% 66.6% 66.7% 9.6% -1.4% -2.7% -12.1% 56.4% 2012F 9.3 -2.5% 85.0% 53.0% 70.8% 10.5% 1.6% 3.1% 15.3% 80.0% 2013F 9.5 -2.5% 85.0% 48.2% 66.5% 10.0% 2.0% 3.7% 19.4% 80.0% 2014F 9.4 -2.5% 85.0% 45.9% 66.3% 9.9% 2.2% 3.9% 20.7% 80.0%

Share price performances, YTD

UBA Access First Bank Zenith Diamond Guaranty ALSI 0.0% 12.3% 10.0% 20.0% 30.0% 40.0% 50.0% 60.0% 70.0% 80.0% 90.0% 25.0% 25.0% 22.1% 36.7% 60.4% 81.1%

Valuation
Price/Preprovision Price/Preprovision EPS FY11A EPS FY 12F Access Diamond First GTBank UBA Zenith 5.0 1.2 3.6 6.0 3.8 5.6 2.4 0.6 3.0 5.5 2.7 4.1

Average

4.2

3.1

Peter Mushangwe

+27 11 551 3675 peterm@legae.co.za

Capital needs some boosting: The banks CAR of 15.2% is ample but provides a thin buffer to the implied minimum of 15% and relative to peers. The Bank intends to raise more Tier 2 Capital, ~$400mn and we believe this is the way to go given underutilisation of non-dilutive capital in the system. However, ability to raise the amount is not a foregone conclusion given that the bank previously raised $100mn instead of the $200mn that management had indicated. Nonetheless, management is optimistic that discussions with lenders are going to yield positive results. The risk assets growth guided by management could quickly reduce the CAR should the bank fail to raise additional capital. Dilution risk is possible should the bank fail to secure non-dilutive Tier 2 capital as it could resort to equity capitalisation, or asset growth (and profitability) in our forecasting period could be lower than guidance. but we take comfort that Diamond seem to take a liability driven approach on balance sheet growth: The comforting argument is that Diamonds asset growth is liability driven. The bank mobilises deposits/funding before searching for assets to apply the deposits/funding to. As a result, the risk of expanding the asset side of the balance sheet is constrained by this approach, which to an extent, ensures CAR remains healthy even if the bank fails to raise some Tier 2 capital, in the short-term. With 56% of the loan book maturing within 12 months, the bank has a better ability to manage its asset growth, in the short-term. Valuation: As we mentioned before, we believe Diamonds valuation is suppressed by expectations of further deterioration/slower than expected improvements in asset quality and profitability. The stock is trading at a forward PBVR of 0.3x vs. our Justified PBVR is 0.7x. On a P/PPOP basis, Diamond remains the cheapest stock at 1.6x (FY11) and forward of 0.6x vs. the average of 4.2x and 3.1x respectively for our Nigerian universe. Post revision to our assumptions, the stock moves into our cheap but value destroying banks quadrant (considering the average ROE over our three year forecasting period). (see Fig 3 Fig 4) Key catalysts: We see 1) resilience in asset quality as a primary catalyst for the stock, particularly in 4Q12; and 2) 3Q12 results that should confirm the management targets/guidance which targets/guidance management has overwhelmingly missed in the recent past. Negative catalysts include 1) slower CASA accretion due to competition (and branch expansion into lower yielding areas); 2) worse than anticipated asset quality and 3) further disappointment/surprises/once-offs at FY12. Miscellaneous: We will review our forecast and valuation for First, Zenith and GT upon 1H12 results releases. However, we maintain our BUY recommendations for First and Zenith for now considering the positive sentiment in the market and the low valuation metrics.
Page 2 of 6

Fig 1: Assumptions - We revise the LDR and IEA yields upwards, provisions downwards

2008
Assumption changes Deposit grow th rate Loan/Deposit ratio

2009 11.2% 61.1% 16.8% -7.2% 8.6% -0.4% 0.4% 0.0% 0.2% 0.2% 0.1% -6.1% -8.6% -12.4%

2010 -14.5% 71.4% 15.4% -3.6% 6.0% -0.2% 0.3% 0.2% 0.1% 0.2% 0.1% -7.8% -7.8% -72.2%

2011 46.0% 56.4% 11.7% -1.8% 7.3% -0.2% 0.3% 0.0% 0.0% 0.1% 0.1% -6.9% -13.0% -30.8%

NEW 2012F 25.0% 75.0% 11.0% -3.0% 5.3% -0.2% 0.3% 0.1% 0.0% 0.0% 0.1% -5.5% -5.0% -30.0%

NEW 2012F 25.0% 80.0% 13.0% -3.0% 5.0% -0.2% 0.3% 0.1% 0.0% 0.0% 0.1% -5.5% -4.8% -30.0%

NEW 2013F 22.5% 80.0% 10.8% -3.0% 5.5% -0.2% 0.3% 0.2% 0.0% 0.0% 0.1% -5.0% -5.0% -30.0%

NEW Average 5yr 2013F 2011-2013 Average 25.0% 80.0% 12.5% -3.0% 5.5% -0.2% 0.3% 0.2% 0.0% 0.0% 0.1% -5.0% -4.5% -30.0% 32.0% 72.1% 12.4% -2.6% 5.9% -0.2% 0.3% 0.1% 0.0% 0.0% 0.1% -5.8% -7.4% -30.3% 36.0% 58.6% 13.2% -3.9% 8.1% -0.2% 0.3% 0.1% 0.1% 0.3% 0.1% -6.2% -6.5% -31.5%

92.8% 57.3% 7.9% -2.8% 7.8% -0.1% 0.3% 0.1% 0.0% 0.5% 0.0% -4.3% -2.0% -20.9%

Interest income/IEA Interest expense/IBL Fee and commission income/Loans Fee and commission expense/Loans Foreign exchange income/TA Trading income/TA Underwriting profit/TA Investment income/TA Other income/TA Operating expense/TA Provision for loan losses/Loans
Taxation/PBT

Source: Company reports, Legae Calculations Fig 2: Assumptions - Provisions have historically grown faster provisions/loans ratio to stabilise at ~4.5% in our forecasting period.
120% Pre-provision profit 100% 100% 1200% 87% 1000% 80% 800% 60% 45% 40% 29% 20% 200% 115% 0% -80% -20%
2006 2007 2008 2009

than

PPOP.

We

expect

the

Provisions, RHS 98%

1400% 14.0% 1200% 12.0%

Provisions/loans

Average 13.01%

10.0% 8.63% 8.0% 7.77%

600% 34% 6.0% 25% 400% 4.0% 93% 1% -35% -9%

2010 2011 2012F 2013F 2014F

412%

4.75% 2.00% 0.21% 2.22%

4.50%

4.50%

-7%

2.0% 18% 20% 0% 0.0%

2.00%

2005

2006

2007

2008

2009

2010

2011

2012F

2013F

2014F

-200%

Source: Company reports, Legae Calculations

Page 3 of 6

Fig 3: Relative valuation On a price/pre-provision earnings basis, Diamond is the most attractive

Current Price Access Diamond First GTBank UBA Zenith 7.70 2.40 12.17 17.40 4.60 15.23

Preprovision EPS FY11 1.55 1.93 3.38 2.88 1.20 2.71

Preprovision EPS FY12 3.21 3.81 4.12 3.16 1.68 3.71

Price/Preprovision Price/Preprovision EPS FY11A EPS FY12F 5.0 1.2 3.6 6.0 3.8 5.6 2.4 0.6 3.0 5.5 2.7 4.1

Average

4.2

3.1

Source: Bloomberg, Company reports, Legae Calculations

Fig 4: and moves into our cheap but value destroying banks quadrant applying our average 3yr ROE forecast
3.0 PBVR y = 3.3361x - 2.3546 R = 0.8644
Expensive value destroying banks Expensive value creating banks

Stanbic

StanChart Barclays

2.5 Equity Kenya

GT bank 2.0 Coop DFCU

1.5 Zenith Nigeria 1.0 Access 0.5 Diamond First UBA

KCB

C heap value destroying banks

C heap value creating banks

0.3 0.4 0.5 0.6 0.7 0.8 0.9 1 1.1 ROE/CoE 1.2 1.3 1.4 1.5 1.6

Source: Bloomberg, Legae Calculations

Page 4 of 6

Fig 5: Financial forecasts: We expect PAT of Ngn18.6bn supported by declining provisions for losses
Interest income Interest expense Net interest income Fee and commission income Fee and commission expense Net fee commission income Foreign exchange income Other income Operating income Operating expense Provision for loan losses Profit before tax Taxation Profit after tax Balance Sheet Loans and Advances Total assets Customer deposits Total liabilities Total equity RWAs equivalent Growth rates Interest income Interest expense Net interest income Fee and commission income Fee and commission expense Net fee commission income Foreign exchange income Other income Operating income Operating expense Provision for loan losses Profit before tax Taxation Profit after tax Balance Sheet Loans and Advances Total assets Customer deposits Total liabilities Total equity RWAs equivalent 2005 10 388 -3 215 7 173 5 175 -1 5 174 279 76 12 737 -8 373 -850 3 514 -1 005 2 510 42 573 130 654 80 013 109 818 20 836 72 472 2006 14 854 -4 612 10 242 7 279 -168 7 110 481 65 17 933 -12 315 -172 5 445 -1 468 3 977 80 560 223 651 148 563 192 629 31 022 127 571 43% 43% 43% 41% 26177% 37% 72% -14% 41% 47% -80% 55% 46% 58% 89% 71% 86% 75% 49% 76% 2007 25 335 -9 025 16 310 10 987 -164 10 823 947 70 30 295 -19 047 -2 240 9 008 -1 921 7 087 100 972 320 950 217 737 267 696 53 254 173 747 71% 96% 59% 51% -3% 52% 97% 8% 69% 55% 1200% 65% 31% 78% 25% 44% 47% 39% 72% 36% 2008 35 725 -12 379 23 346 18 765 -326 18 439 1 906 199 47 733 -26 711 -4 808 16 214 -3 393 12 821 240 449 625 670 419 708 508 414 117 256 410 981 41% 37% 43% 71% 99% 70% 101% 183% 58% 40% 115% 80% 77% 81% 138% 95% 93% 90% 120% 137% 2009 77 825 -35 831 41 993 24 458 -1 274 23 184 3 033 423 71 875 -41 349 -24 623 5 903 -730 5 173 285 345 682 078 466 890 567 640 114 438 505 698 118% 189% 80% 30% 291% 26% 59% 113% 51% 55% 412% -64% -78% -60% 19% 9% 11% 12% -2% 23% 2010 66 176 -16 293 49 883 17 777 -529 17 248 1 909 524 74 200 -46 565 -22 862 4 773 -3 444 1 329 294 228 594 795 412 032 487 710 107 085 462 434 30% -35% 93% 51% 39% 51% -2% 50% 75% 55% -8% -139% -182% -116% -3% -9% -15% -10% 1% -6% 2011 67 936 -12 286 55 650 24 675 -578 24 098 2 020 669 83 444 -55 580 -44 148 -16 261 5 007 -11 254 339 267 803 707 601 696 710 374 93 333 580 830 3% -25% 12% 39% 9% 40% 6% 28% 12% 19% 93% -441% -245% -947% 15% 35% 46% 46% -13% 26% 2012F 102 570 -19 567 83 003 30 085 -1 203 28 881 3 436 641 117 190 -62 081 -28 581 26 528 -7 958 18 570 601 696 1 128 742 752 120 1 057 075 121 571 971 405 51% 59% 49% 22% 108% 20% 70% -4% 40% 12% -35% NM NM NM 77% 40% 25% 49% 30% 67% 2013F 119 244 -24 315 94 930 41 367 -1 504 39 862 4 366 861 142 772 -68 819 -33 845 40 107 -12 032 28 075 752 120 1 376 388 940 150 1 309 273 144 866 1 207 169 16% 24% 14% 38% 25% 38% 27% 34% 22% 11% 18% 51% 51% 51% 25% 22% 25% 24% 19% 24% 2014F 142 330 -29 158 113 172 49 640 -1 805 47 835 5 281 1 116 170 702 -78 311 -40 614 51 776 -15 533 36 243 902 544 1 648 656 1 128 179 1 561 579 175 465 1 449 794 19% 20% 19% 20% 20% 20% 21% 30% 20% 14% 20% 29% 29% 29% 28% 19% 20% 2% 21% 26%

Source: Company reports, Legae Calculations

Page 5 of 6

Legae Securities (Pty) Ltd

Member of the JSE Securities Exchange 6A Sandown Valley Crescent, Sandown, Johannesburg, 2196, South Africa P.O Box 650361, Benmore, 2010, South Africa Tel +27 11 722 7330, Fax +27 11 722 7330 Web: www.legae.co.za email: research@legae.co.za

Analyst Certification and Disclaimer I/we the author (s) hereby certify that the views as expressed in this document are an accurate of my/our personal views on the stock or sector as covered and reported on by myself/each of us herein. I/we furthermore certify that no part of my/our compensation was, is or will be related, directly or indirectly, to the specific recommendations or views as expressed in this document This report has been issued by Legae Securities (Pty) Limited. It may not be reproduced or further distributed or published, in whole or in part, for any purposes. Legae Securities (Pty) Ltd has based this document on information obtained from sources it believes to be reliable but which it has not independently verified; Legae Securities (Pty) Limited makes no guarantee, representation or warranty and accepts no responsibility or liability as to its accuracy or completeness. Expressions of opinion herein are those of the author only and are subject to change without notice. This document is not and should not be construed as an offer or the solicitation of an offer to purchase or subscribe or sell any investment. Important Disclosure This disclosure outlines current conflicts that may unknowingly affect the objectivity of the analyst(s) with respect to the stock under analysis in this report. The analyst(s) do not own any shares in the company under analysis.