DBRS Downgrades KBC Group’s Senior Debt to A(low); ST to R-1(low) Following Removal of Belgian Floor

DBRS, Inc. (DBRS) has today downgraded the Senior Long-Term Debt & Deposits ratings of KBC Group N.V.’s (KBC or the Group) to “A (low)” and the Senior Long-Term Debt & Deposits of KBC Bank N.V (KBC Bank) at “A”, KBC’s principal banking subsidiary. The trend for all ratings is Stable. At the same time, DBRS has confirmed the Intrinsic Assessments (IAs) of KBC Bank at A (low) and the Group at BBB (high). KBC is considered a systemically important banking organisation with an SA2 designation that results in a one-notch uplift for the final ratings above their IAs.

These rating actions conclude the review that was initiated after DBRS removed the rating floor for critically important banking organisations in Belgium on October 11, 2013. The floor was A (high) for banks and “A” for bank holding companies, resulting in two notches of uplift between the IAs and final ratings for the Group and KBC Bank.

While the floor is no longer warranted given the improved financial markets and strengthened banking system, DBRS still expects that some level of timely systemic support for KBC would be forthcoming in the event of a stress scenario. This designation results in the SA2 support assessment, which gives a one-notch uplift from the IAs to the final ratings.

The confirmation of KBC’s IAs reflects the Group’s successful completion of the restructuring plan agreed with the EC. This success is indicated by its simplified structure launched in 2013 and its improved earnings, strengthened funding profile, and improved capitalisation. Now with EUR 250 billion in assets, KBC has emerged from its restructuring phase. The IA also considers the potential stress from its business in Ireland given the still weak Irish economy, and the constraint on its financial flexibility with the remaining state aid to be repaid.

The Stable trend reflects KBC’s increased resiliency given its well-executed reduction of RWAs (reduced by 42% since end-2008 to EUR 90.2 billion) that has been mostly driven by the series of divestments and sale of legacy assets. Also reflective of KBC’s progress is the partial reimbursement that the Group made to the Belgian State in line with what KBC has announced. Out of an initial EUR 7 billion, KBC now has only EUR 2.33 billion (plus a 50% penalty, i.e. EUR 1,165 million) of non-voting core capital securities issued to the Flemish Regional Government. DBRS perceives that KBC has the ability to repay the EUR 2.33 billion in seven equal installments over the 2014-2020 period – as they committed to. DBRS notes that KBC may pay back sooner based on its own decision, subject to regulatory approval.

Also supporting the Stable trend is KBC’s strong core franchise in Belgium, which remains a key strength of the Group and its ability to withstand stress. The Belgian business unit, the largest contributor to Group’s earnings, reported EUR 1.2 billion of adjusted net income in 9M13, up from EUR 1.1 billion in 9M12. Second key contributor to earnings is the Czech Republic business unit, which posted EUR 0.4 billion of adjusted net income in 9M13, stable from 9M12 – illustrating KBC’s ability to succeed outside of Belgium. But International Markets are not profitable yet, this is due primarily to the elevated level of provisioning that persists in KBC’s bank in Ireland, which the Group does not expect to be profitable until 2016.

In 9M13, provisions of EUR 991 million absorbed just 34% of the Group’s income before provisions and taxes (IBPT) of EUR 2.9 billion in 9M13, compared to EUR 2,048 million provisions absorbing 76% of EUR 2.7 billion of IBPT in 9M12 under IFRS. At the same time, the Group has announced in November 2013 an estimated one-off provision of EUR 775 million for 4Q13 that results from the Group’s review of its Irish loan portfolio to address the European Banking Authority’s paper on forbearance and non-performing loans and the asset quality review to be performed in 2014. This appears manageable at 91% of 3Q13 IBPT and compares to IBPT of about the same level in 4Q12.

Contributing to the level of underlying earnings, the Group’s IBPT is benefiting from improved efficiency. For the Group’s banking business, the cost-to-income ratio on an underlying basis improved to 56% year-to-date. Under IFRS, the cost-to-income ratio in banking was even lower at 51%.

Also supporting the level of the IA, DBRS views KBC’s funding profile as strong. With funding from customers representing roughly 75% of total funding at September 2013, KBC has available liquid asset of EUR 60.1 billion, covering 388% of net short term funding. KBC has been compliant throughout 9M13 with The Net Stable Funding Ratio (NSFR) and Liquidity Coverage Ratio (LCR) under current assumptions.

Adding to its buffer over regulatory minimums, KBC’s common equity ratio (CET1) reached 12.5% at September 2013 under fully loaded Basel III, up 170 basis points (bps) from end-2012. Its fully loaded Basel III leverage ratio is estimated at 3.8% at September 2013 at KBC Bank consolidated (as applied by KBC). The EUR 2.33 billion remaining State aid is included in CET1, representing 20% of total CET1. In November 2013, KBC’s capital level was further improved by approximately 70 bps following the announced sale of shares by KBC’s main shareholders and the concomitant reimbursement of shareholders loans.

More of a challenge for KBC is its overall non-performing loan (NPL) ratio that remains elevated. Now at 5.8%, the increase in NPL ratio is driven primarily by the Irish bank subsidiary with a NPL ratio in that reached a new high of 25.9% in September 2013. Specific and portfolio-based loan impairments for performing and non-performing loans were 63%.

Upward rating pressure could arise, if KBC continues to make progress in improving its profitability, while further enhancing its balance-sheet and risk profile. Negative rating pressure could occur, if KBC were to have difficulties in improving its risk profile in its overseas subsidiaries, or if it was unable to sustain its planned reimbursement of remaining State aid while remaining compliant with regulatory minimums.

Notes:
All figures are in euros (EUR) unless otherwise noted.

The principal applicable methodology is the Global Methodology for Rating Banks and Banking Organisations. Other methodologies used include the DBRS Criteria – Intrinsic and Support Assessments. These can be found on the DBRS website under Methodologies.

The sources of information used for this rating include company documents and SNL Financial. DBRS considers the information available to it for the purposes of providing this rating was of satisfactory quality.

This rating is endorsed by DBRS Ratings Limited for use in the European Union.

Lead Analyst: Roger Lister
Rating Committee Chair: Alan G. Reid
Initial Rating Date: 3 June 2010
Most Recent Rating Update: 9 December 2013

For additional information on this rating, please refer to the linking document under Related Research.