DBRS: KBC’s Underlying Net Income is Holding Up; Lower Costs, Provisions

Summary
• On an adjusted basis, KBC earnings held up in Q1 2014, posting EUR 387 million in net income excluding the impact of the legacy business (CDOs, divestments) and the valuation of own credit risk. This result was up from EUR 359 million in Q1 2013 and EUR 348 million in Q4 2013 if the large provision for Ireland is excluded, but down from the EUR 412 million quarterly average for 2013.
• Belgium Business Unit (BU) showed resiliency with increased net interest margin (NIM); Czech Republic contribution was up even after FX adjustment; and International BU’s cost of risk improves overall.
• Basel III fully loaded common equity tier 1 (CET1) ratio remains solid at a stable level of 12.5% despite changes in Belgian regulation.
• DBRS rates KBC Group N.V.’s (KBC or the Group) Senior Long-Term Debt & Deposits at A (low) and the Senior Long-Term Debt & Deposits of KBC Bank N.V. (KBC Bank), KBC’s principal banking subsidiary, at “A”. The trend for all ratings is Stable.

From DBRS Inc.’s (DBRS) perspective, the Q1 2014 results show KBC success in simplifying and de-risking its business model that has strengthened its capacity to generate earnings. The Group improved its capacity to generate earnings on an adjusted basis, after excluding the impact of the legacy business (CDOs, divestments) and the valuation of own credit risk. Adjusted net income is up 8% year-on-year (YoY) to EUR 387 million in Q1 2014. However, reported net income was EUR 397 million in Q1 2014, down from EUR 520 million in Q1 2013. One-off items were only EUR 10 million in Q1 2014, but totalled EUR 161 million positive one-off in Q1 2013, mainly reflecting the revaluation of the structured credit portfolio.

On an adjusted basis, income before provisions and taxes (IBPT) of EUR 619 million is down 27% from Q1 2013. This was driven by a non-negligible negative marked-to-market (MtM) valuation of asset and liability management (ALM) derivatives of EUR -201 million that drove overall revenues down. Compared with Q1 2013 though, net interest income and net fee and commission were relatively stable, while insurance operations posted good performance - up from Q1 2013. The overall decrease in revenues was only partially compensated by successful costs control. Group’s operating expenses were 5.7% down YoY. Provisions of EUR 107 million, compared to EUR 333 million in Q1 2013, absorbed just 17% of IBPT compared to 39% the previous year.

Improving trends were evident in the Group’s business units. The Belgium business unit (BU) showed resiliency, as net interest income (NII) was up 6% YoY to EUR 696 million despite the reduction in loans in this BU’s foreign branches. This increase was driven by the BU’s improved NIM, up 20 basis points (bps) YoY to 1.98% in Q1 2014. Provisions also remained on a downward trend. Expenses were down marginally. Overall Belgium BU revenues were nevertheless down 15% YoY, due to a negative change in ALM derivatives of EUR – 86 million, so net income was reduced to EUR 351 million, down 9% YoY. Net contribution from the Czech Republic BU is up even after FX adjustment; NIM was maintained at a solid 3.29%. Net loss in the International Markets BU was limited to EUR 26 million in this quarter compared to EUR 87 million in Q1 2013. This was supported by an improved cost of risk but also improved revenues. NII was stable from the quarterly average, and NIM up 20 bpsYoY to 2.26%.

The pace of provisioning remains on a downward trend, excluding the large provision for lending in Ireland in Q4 2014. The improvement in the cost of risk was evident in every BU. Overall, KBC’s credit cost improved in Q1 2014 reaching 29 bps, down 92 bps from end-2013. The magnitude of this drop was magnified by higher level of impairment in Belgium in 2013 and important recoveries in all three BUs. The impairments level in Ireland is in line with the Group’s guidelines. Nevertheless, KBC’s overall non-performing loan (NPL) ratio remains elevated. At 5.9%, up from 5.4% in Q1 2013, the increase in NPL ratio remains driven primarily by the Irish bank subsidiary. While the trend was stable or improving in the other subsidiaries, the NPL ratio in Ireland reached a new high of 27.4% in Q1 2014 relative to 24.0% in Q1 2013, and 26.2% in Q4 2013. Group’s specific and portfolio-based loan impairments for performing and non-performing loans were 71% at Q1 2014 vs. 72% at end-2013.

The Group is maintaining its capitalisation at a solid level. KBC anticipated the abolishment of the zero-weight for home country-government debt soon to be required by the National Bank of Belgium, which led to 5% increase in risk-weighted assets (RWAs). This had a limited impact. The Group reported a solid pro-forma Basel III fully loaded CET1 ratio of 12.5% pro-forma at Q1 2014, stable relative to Q4 2013.

DBRS rates KBC Group N.V.’s (KBC or the Group) Senior Long-Term Debt & Deposits at A (low) and the Senior Long-Term Debt & Deposits of KBC Bank N.V (KBC Bank), KBC’s principal banking subsidiary, at “A”. The trend for all ratings is Stable.

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