DBRS: KBC’s Ratings Unchanged Following 3Q10 Results; Senior at “A”, Trend is Stable

DBRS has today commented that its ratings of KBC Group N.V. (KBC or the Group) remain unchanged after KBC’s 3Q10 results. DBRS rates KBC’s Senior Long-Term Debt & Deposits at “A” and KBC Bank N.V.’s Senior Long-Term Debt & Deposits at A (high). All ratings have a Stable trend. KBC reported profit attributable to equity holders of the parent of EUR 545 million in 3Q10, a sharp improvement from EUR 149 million in 2Q10 and up slightly from EUR 528 million in 3Q09. Results were driven by continued solid net interest income in Belgium and strong dealing room revenues, combined with underlying expense control and improving trends in asset quality.

Results for 3Q10 demonstrated the strength of the franchise in generating revenue growth, the resiliency of KBC’s underlying earnings and its ability to absorb the impact of its ongoing restructuring. On an underlying basis, which excludes certain exceptional or non-operating items, KBC generated net interest income of EUR 1.4 billion, a 1% increase both quarter-over-quarter (QoQ) and year-over-year (YoY), largely driven by loan growth in its home market of Belgium. Net interest margin (NIM) improved to 1.92%, an increase of 5 basis points QoQ, despite pressure on margins in Belgium with lower reinvestment yield on assets and increased competition. The Group continues to cope reasonably well with the stresses of the current economic downturn within Central and Eastern Europe (CEE), as NIM in CEE improved to 3.21% in 3Q10 from 3.03% in 3Q09. KBC generated total underlying income of EUR 2.2 billion in 3Q10, approximately the same level as the first two quarters of 2010 and around the average for 2009, demonstrating that underlying revenues held up in the core businesses. On a reported basis, revenues for the Group were positively impacted by a net unrealised gain of EUR 227 million on assets that are marked-to-market (MTM), a sharp turnaround from a net unrealised loss of EUR 721 million in the prior quarter, boosting total income by 49% QoQ to EUR 2.2 billion in 3Q10.

Improved efficiency combined with recurring revenues helped the Group to deliver income before provisions and taxes (IBPT) of EUR 1.1 billion in 3Q10, more than double the EUR 460 million generated in 2Q10 and 38% higher than in 3Q09. Operating expenses were down YoY, benefitting from cost containment measures initiated in 2008, but increased as compared to 2Q10 due to one-time items, such as the full-year cost of the Hungarian bank tax booked in 3Q and costs related to the Belgian Deposit Guarantee Scheme. The 9M10 cost-to-income ratio was 53%, on an underlying basis, down from 55% for full year 2009. Provisioning continues to show generally improving trends, with impairments of EUR 420 million in 3Q10 down from a peak of EUR 969 million in 4Q09. With impairments absorbing just 38% of IBPT, down from 55% in 3Q09, DBRS views these levels as manageable, particularly given improving trends across KBC’s business areas.

Across the geographies in KBC’s franchise, results generally displayed improvement. Despite facing the challenge of increased competition as competitors are becoming stronger with improving markets, KBC’s franchise resiliency was evident in the solid results in Belgium. KBC has grown lending in its home market by 5% YoY, mainly in mortgages (+9%), and assets under management were up 2% YoY, while customer deposits held flat. Adding an important component to its franchise diversity, CEE, which includes the Czech Republic, Slovakia, Hungary, Poland and Bulgaria, is coping reasonably well with the stresses of the current economic downturn, generating net profits in 3Q10 in all markets except Hungary. Within CEE, KBC generated strong net interest income with organic growth and wider margins, while maintaining a solid loan-to-deposit ratio of 77%. As a universal bank, KBC’s wholesale banking capabilities provide it with significant opportunities to generate solid earnings through its well-positioned customer franchises. In Merchant Banking (MB), results were mixed as KBC generated strong net profits in market activities due to solid results in its dealing rooms, while commercial banking results were negatively impacted by higher impairments in KBC Bank Ireland and a few large international credits. In MB, KBC continues to scale back, focusing on markets where it is well-established and reducing risk-weighted assets (RWA) by 11% YoY.

KBC is still struggling with elevated credit costs. The Group’s non-performing loan (NPL) ratio rose marginally QoQ to 4.0% in 3Q10, with increases driven by CEE and MB business units. In CEE, with an NPL ratio of 5.6%, up from 5.2% in 2Q10, nonperforming loans are driven by general weak economic development and high levels of unemployment. In MB, with an NPL ratio of 4.8%, up from 4.1% in 2Q10, nonperforming loans are largely driven by KBC Bank Ireland which had an NPL ratio of 9.0% in 3Q10. Even so, KBC still expects this bank to have positive earnings in 2010. Positively, the ratio in Belgium has stabilised at a low level of 1.5% and has been running at around this consistently lower pace throughout the crisis. The Group provisioned accordingly, with impairments of EUR 420 million, maintaining a sufficient coverage ratio of 75%.

Besides the strengths in its core businesses, DBRS sees KBC as having success in its restructuring of its non-core business through planned divestments and run-off portfolios. The Group is absorbing the cost of dispositions and coping with the earnings drag from companies that are earmarked for future divestment. KBC houses these activities largely in the Group Centre, which generated a marginal net profit in 3Q10. Of note is the significant deterioration in Absolut Bank, the Group’s subsidiary in Russia, which reported an NPL ratio of 18.3% in 3Q10, a significant jump from 9.2% in 3Q09. Positively, KBC was able to absorb these “burdens” and deliver another quarter of positive earnings.

DBRS views KBC’s liquidity position as solid, given its ability to generate deposits in its core businesses and its strong loan-to-deposit ratio of approximately 85% at 3Q10. Maintaining solid capital levels, the Group’s core capital ratio was 10.4% and Tier 1 ratio was 12.1% at the end of 3Q10. Based on its current interpretation of Basel III, the Group estimates that its core Tier 1 would be approximately 8.0% at the end of 2013, without needing a capital increase. DBRS anticipates that the Group has the ability to adjust to the evolving regulatory environment and maintain appropriate capital levels.

Notes:
All figures are in EUR unless otherwise noted.

The applicable methodologies are Global Methodology for Rating Banks and Banking Organisations and Enhanced Methodology for Bank Ratings – Intrinsic and Support Assessments, which can be found on our website under Methodologies.

This rating did not include issuer participation and is based solely on publicly available information.