KBC Group Remains One Of The Best Income Options In The European Banking Sector (OTCMKTS:KBCSF)

noel bennett KBC Group (OTCPK:KBCSF) offers a sustainable high-dividend yield within the European banking sector, but its valuation sees fair right now. As I’ve covered in previous articles, KBC is one of my preferred European banks due to its strong fundamentals and attractive income profile. Despite that, I downgraded my recommendation some months ago because interest rates reached a top in Europe and there were some prospects of rate cuts ahead, which would be negative for its earnings momentum. While the European Central Bank has indeed cut its main rate quite recently, interest rates remain relatively high in Europe, a background that is positive for retail banks, like KBC. This has been an important support for its share price over the past few months, leading to a total return of more than 31% since my last article on KBC. As I’ve not covered KBC for a while I think it’s now a good time to analyze its most recent financial performance and update its investment case, to see if it remains a good income pick in the European banking sector for long-term investors. KBC 1Q 2024 Earnings During the first quarter of 2024, KBC has reported a positive operating performance supported by its bancassurance business model, with both banking and insurance operations performing well in recent months. The bank was able to report loan growth and deposit growth in the first quarter, which is a positive outcome considering strong competition in the market, especially on the deposits side which has been under pressure by the issue bonds for retail from the Belgian government. Nevertheless, KBC was able to report some growth in net interest income (NII), up by 3% YoY to €1.37 billion in Q1 2024, and also slightly above the level reached in the previous quarter. Net interest income (KBC) As I’ve discussed in previous articles on KBC, the bank is not much exposed to rates due to its business model which has a more diversified revenue mix than most of its European peers, leading to a lower NII weight on total revenues than most European banks, and loans in its major markets are mainly at fixed rates, thus its gearing to rates is relatively low. This explains why despite a rising interest rate environment in Europe over the past couple of years, its NII has been relatively stable, a profile that was not particularly bullish when rates are on an upward trajectory, but it’s now a positive factor considering that rates are expected to decline in the future. Indeed, according to street estimates, the European Central Bank is expected to cut rates several times in the coming months, with the market expecting its main rate to drop from its current level of 4.25% to about 2.5% by the end of 2025. While a rising interest rate environment was positive for banks with higher reliance on NII, such as BBVA (BBVA) for instance, a downward trajectory is expected to put pressure on NII going forward. This means that banks with lower gearing to rates are expected to have a more stable revenue profile going forward, which bodes well for KBC, at least on a relative basis. Regarding commission income, KBC reported an increase of 7% YoY to €614 million in the previous quarter, supported by higher fees in the asset management segment, which was justified by higher management fees as assets under management increased by 19% YoY driven by net inflows and positive market performance. In the insurance segment, it also reported a positive operating performance, with life sales up by 60% YoY to €765 million in the quarter. This strong growth is explained by the successful launch of a structured fund and a commercial action with the Private Banking segment in Belgium, which led to a strong increase of unit-linked sales in the first quarter of the year. Regarding operating expenses, excluding banking and insurance taxes, its underlying costs declined by 1% YoY to €1.06 billion, which is a very good outcome considering the inflationary environment. While wage growth has pressured operating expenses, the sale of its Irish unit had a positive impact on costs. Another important feature which is positive for its operational efficiency is KBC’s efforts to digitalize and automate its customer service, namely through Kate (the bank’s AI assistant). This automates customer service has been well received by its customers, being nowadays used by some 4.5 million KBC’s customers. This AI assistant was implemented three years ago and has a growing acceptance by KBC’s users, enabling the bank to improve productivity. This AI assistant has a very good track record regarding customer’s questions, being able to answer independently about two thirds of the questions, and also by leveraging sales. According to KBC, Kate was responsible for 32,000 extra sales during Q1 2024, being an important tool for the bank to improve its productivity. This is also a great example of how technology and AI can impact banking operations, supporting efficiency improvements in the coming years. Regarding credit quality, it remained quite good given that KBC’s provisions in the quarter amounted to only €16 million (compared to reversals in Q1 2023), representing a cost of risk ratio of only 4 basis points (bps). Credit costs (KBC) This is a very low risk ratio compared to other European banks and while some peers have reported an uptick in credit costs in recent quarters, KBC maintains a very good credit quality. Nevertheless, its guidance is somewhat conservative and the bank expects an increase in credit costs over the coming quarters to a level between 25-30 bps, which is still relatively low and, if macroeconomic conditions remain supportive, can be easily beaten in the coming quarters. Its bottom-line in Q1 2024 was €508 million, relatively unchanged from the same quarter of 2023, and its return on equity (ROE) ratio, a key measure of profitability in the banking sector, was 14%. This is a very good level of profitability compared to peers, showing that KBC has a quality profile. Regarding its capital position, KBC’s CET1 ratio was 14.9% at the end of last March, which is comfortably above its capital requirement and in-line with its medium-term target. As the bank has a good organic capital generation, it has defined a CET1 ratio of 15% as its target, while excess capital will be returned to capital on a discretionary basis, through special dividends, share buybacks, or a combination of both. Indeed, the bank has recently decided to distribute the surplus capital above 15% through a special dividend to shareholders, amounting to €280 million, or €0.70 per share. This was on top of its interim and final dividend of €4.15 per share already paid, which means its total dividend related to 2023 earnings was €4.85 per share. At its current share price, KBC offers a dividend yield of about 7.30%, which is quite attractive to shareholders. For 2024, its dividend policy remains unchanged, expecting to pay at least 50% of its annual earnings to shareholders including AT1 coupons, plus distribute excess capital through special dividends or share buybacks. It expects to pay an interim dividend of €1 per share next November, unchanged from the previous interim dividend, while potential dividend growth will be decided related to the final dividend when it announces its 2024 results (during the first quarter of 2025). Current consensus expects a dividend of €4.62 per share, without considering potential special dividends, thus based on ‘regular’ dividends, the street is expecting KBC to grow its dividend by 11% YoY, which seems sustainable considering the bank’s conservative payout ratio and good organic capital generation. Regarding its valuation, KBC is currently trading at about 1.2x book value, while its historical average over the past five years is 1.26x book value, which means its shares appear to be fairly valued right now. Compared to some of its closest peers, such as ING Groep (ING) or ABN Amro (OTCPK:AAVMY), it’s trading at a premium, being another sign that KBC’s shares aren’t undervalued right now. Conclusion KBC is one of the best banks in Europe due to its strong fundamentals, good asset quality, strong capital position and a high-dividend yield. While during the rising interest rate environment it was not among the banks most geared to rates, on the rates down cycle expected ahead its revenue and earnings stability is a plus, making it a good income play in the European banking sector. Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.

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