DBRS Comments on KBC Bank Rating Actions – IA raised to A

As detailed in the press release “DBRS Downgrades 31 European Banking Groups due to Removal of Systemic Support Uplift”, published earlier today, DBRS Ratings Limited (DBRS) confirmed the ratings of KBC Group N.V.’s (KBC or the Group) and of KBC Bank N.V (KBC Bank), including the Short-Term Debt and Deposits ratings of both KBC and KBC Bank at R-1 (low). The trend on all ratings is now Stable. The confirmation reflected a change in DBRS’s support assessment for KBC to SA3, from SA2, which resulted in the removal of one notch of uplift from the Intrinsic Assessment (IA) for potential systemic support. However, concurrently, KBC Group’s IA has been raised to A (low) from BBB (high), and KBC Bank’s IA has been raised to A from A (low), mitigating the removal of the uplift for support. This commentary provides further background on the change in the IAs.

RATIONALE FOR THE CHANGE IN THE IA:

The improvement in KBC Bank’s IA to A reflects the continued progress of the Bank in 1H15 that demonstrates its fundamental strengths, especially with regard to profitability, improving risk profile and capital. In 1H15, KBC reported income before provisions and taxes (IPBT) of EUR 1.8 billion, a 52% increase year-on-year (YoY) mostly driven by strong performance in Belgium, the Group’s main market, as well as in the Czech Republic. The improvement was driven by more volume on the back of an improved macro environment and a successful bancassurance model, which channels cross-selling, as well as controlled operating costs. KBC’s cost-to-income (banking) was 55% at June 2015, down from 58% in 2014 in the context of indexed salaries and higher bank taxes in Belgium. In 1H15, net profit was EUR 1.2 billion, significantly up from EUR 0.7 billion in 1H14 confirming KBC’s capacity to generate solid earnings.

KBC has also reported further strengthening of its capital in 1H15. At end-June 2015, the fully-loaded common equity tier 1 (CET1) ratio was 16.7%, up 240 basis points (bps) from end-2014. Out of an initial EUR 7 billion in state aid, KBC now has EUR 2.0 billion remaining of non-voting core capital securities issued to the Flemish Regional Government. This remaining State aid is included in CET1, but DBRS estimates that KBC’s CET1 ratio without the State aid would still be at a solid level of 14.4%. Consequently, DBRS considers that KBC has the ability to repay the EUR 2.0 billion and related EUR 1.0 billion penalty by 2017 taking trends in its earnings into account, ahead of the 2020 initially agreed with the EC, subject to regulatory approval. This compares to a minimum ECB target of 10.5%. Based on current CRR legislation, KBC’s leverage ratio was up to 6.7% at June 2015 from an already solid level of 6.4% at end-2014.

The Bank also continued to report improvements in its asset quality with a Group’s cost of risk of 30 bps at June 2015 down 12 bps from end-2014 and the high of 122 bps in 2013. Contributing to this level is the low cost of risk across the Bank’s main businesses, but also the reduced credit costs in International Markets, in particular in KBC’s Irish bank subsidiary. The cost of risk in Ireland was significantly down to 32 bps at June 2015 from 133 bps at end-2014. Also trending down, KBC’s overall non-performing loan (NPL) ratio is 5.3%, down from 6.2% at end-June 2014 and 5.5% at end-2014.

RATING DRIVERS:

The Trend on the Group’s ratings is now Stable. Further upward movement in the senior ratings could occur if KBC were to maintain the current pace of profitability, while making further progress in restructuring the weaker parts of its International Markets business unit, such as Ireland and Hungary. Downward pressure on the IA is not expected, but could occur if KBC were to have difficulties in its CEE franchises, if economies were to weaken, if the reimbursement of the remainder of State aid were to significantly pressure KBC’s regulatory capital position, or if there was a combination of these factors.

SUPPORT ASSESSMENT:

This rating action concluded the rating review initiated in May 2015, and reflected DBRS’s view that developments in European regulation and legislation mean that there is less certainty about the likelihood of timely systemic support. Countries across Europe continue to make progress in enacting the Bank Recovery and Resolution Directive (BRRD) into national legislation, including Belgium. BRRD has harmonised the approach that will be taken in the resolution of failing banks across Europe, and has led DBRS to conclude that there is not sufficient certainty of support to have any uplift in the senior debt ratings of European banks. Consequently the support assessment for KBC was changed to SA3 (the category for banks in countries where DBRS has no expectation of systemic support or is not confident enough that timely systemic support would be forthcoming in times of need to add a notch for systemic support) from SA2 (indicating the likelihood of timely systemic support).

RATIONALE FOR THE UPGRADE OF THE JUNIOR SECURITIES:

DBRS earlier today also upgraded the Junior Subordinated Debt issued by KBC Bank to BBB, from BBB (low). DBRS's approach is to notch junior securities from the bank's Intrinsic Assessment (IA), and therefore as a result of the improvement in KBC Bank’s IA the Junior Subordinated Debt has been upgraded.

Notes:
All figures are in EUR unless otherwise noted.