Belfius Bank SA/NV. Primary Credit Analyst: Philippe Raposo, Paris (33) ;

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1 Primary Credit Analyst: Philippe Raposo, Paris (33) ; Secondary Contact: Nicolas Hardy, Paris (33) ; Table Of Contents Major Rating Factors Outlook Rationale Related Criteria And Research MARCH 3,

2 SACP bbb+ + Support 0 + Additional Factors +1 Anchor a- Business Position Capital and Earnings Adequate 0 Adequate 0 Risk Position Moderate -1 Funding Liquidity Average Adequate 0 ALAC Support 0 GRE Support 0 Group Support 0 Sovereign Support 0 Issuer Credit Rating A-/Stable/A-2 Major Rating Factors Strengths: Weaknesses: Stable and top-tier domestic market position with good business diversification between banking and insurance services. Low credit risk in core lending activities. Improving earnings capacity and internal capital generation. Less diversified by geographies and businesses than larger European peers. Sensitive to market risk due to the large size of non-loan assets on the balance sheet. Completion of the so far well executed divestment of non-core assets. Outlook: Stable The stable outlook on Belfius Bank reflects S&P Global Ratings' view that in the next months the bank will gradually reap the benefits of a renewed internal commercial momentum, despite the challenging operating and regulatory environment, and further strengthen its capitalization. We could lower our ratings on Belfius Bank by one notch if its capital position does not continue to strengthen according to our expectations. This could happen in case of a more aggressive dividend policy or a more aggressive lending strategy, which would inflate risk assets. In that case, we would likely remove the notch of positive transition. Under this scenario, we do not believe neither that the bank's additional loss-absorbing capacity (ALAC) buffer would reach our required threshold. We see an upgrade as remote in the next two years. We believe Belfius Bank will need time to restore profitability and build loss absorbing capacity in line with 'A' rated peers. MARCH 3,

3 Rationale The ratings on Belfius Bank factor in the bank's 'a-' anchor score and our view of the bank's adequate business position, adequate capital and earnings, moderate risk position, average funding, and adequate liquidity. We assess Belfius Bank's stand-alone credit profile (SACP) at 'bbb+'. Our ratings also reflect our view of the ongoing positive transition that should lead to the expected gradual strengthening of the bank's capital position. This results in a one-notch uplift above the SACP, bringing the issuer credit rating to 'A-'. Anchor: 'a-' for a bank with dominant domestic lending activities We use our Banking Industry Country Risk Assessment economic risk and industry risk scores to determine a bank's anchor, the starting point in assigning an issuer credit rating to a bank. Our 'a-' anchor for a commercial bank operating only in Belgium is based on an economic risk score of '2' and an industry risk score of '3', on a scale of 1-10 ('1' is the lowest risk and '10' the highest). Belfius Bank's weighted economic risk score stands at '2', reflecting that most of the bank's assets are in Belgium. Our '2' economic risk score for Belgium reflects our view that its economy is wealthy, highly diversified, and export oriented, with a net external asset position. A high government debt ratio and a relatively high tax burden constrain the country's economic resilience. In our view, economic imbalances and credit risk in the economy pose a low risk to the banking system. Our assessment of the economic risk trend for Belgium remains negative. In our view, Belgium's export-oriented nature makes it vulnerable to external shocks, which we view as more likely to happen than in the past. We anticipate that uncertainty following the U.K's vote to leave the EU could hit trade and investment activity in the very open Belgian economy. That said, we anticipate modest property price increases supported by resilient domestic demand and a continued recovery in employment. Our industry risk score of '3' reflects our view of the ample domestic funding sources for Belgian banks combined with the challenge of generating revenues from the reinvestment of excess resources without lowering their risk profile. The four largest banks maintain stable and dominant domestic market shares, which underpins industry stability. Regulatory standards are, in our view, in line with those of Belgium's Western European peers. We project stable industry risk. Table 1 Belfius Bank SA/NV Key Figures --Year-ended Dec (Mil. ) 2016* Adjusted assets 170, , , , ,378.7 Customer loans (gross) 76, , , , ,381.4 Adjusted common equity 8, , , , ,948.9 Operating revenues 1, , , , ,458.4 Noninterest expenses , , , ,593.2 Core earnings *Data as of June MARCH 3,

4 Business position: Resilient franchise in Belgium's retail banking market We assess Belfius Bank's business position as adequate. Our view factors in the bank's business concentration in a single country, offset by a stable market position--15% share of the Belgian retail market and above 50% market share in loans granted to the public sector--and the diversification of revenue streams thanks to its bank-insurance model. The bank has been operating under the Belfius name since 2012, but used to belong to the Dexia group under the name Dexia Bank S.A., also know as Dexia Banque Belgique. The former Dexia Bank S.A was acquired by the Belgium government on Oct. 20, 2011, when the Dexia group was facing severe financial difficulties. The objective of the various management teams since then has been to separate the commercial bank in Belgium from the rest of the Dexia group and to ensure the financial and operational viability of the business model. In our view, the bank's full state ownership, through the Federal Holding and Investment Company, since October 2011, has helped the bank navigate through these difficult years of deleveraging and derisking, as well as protect its commercial franchise. We believe Belfius Bank's resilient franchise, based on a deep-rooted branch network and customer loyalty in its domestic public finance business supports stable revenues generation capatity. We expect the residual negative impact of the bank's restructuring to be well controlled. We understand that the bank's active derisking strategy has come to an end in 2017, and that remaining exposures will be either amalgamated with the commercial portfolios or wound down progressively through their natural amortization. Belfius Bank has gradually reduced its noncore exposures inherited from the Dexia era to 10.5 billion at end-2016 from 74 billion as of year-end This legacy book included funding to Dexia, a bond portfolio, and a credit guarantee portfolio. We understand the funding to Dexia has been reduced to negligible amounts since 2015, and both the bond and credit guarantee portfolios are now nearing the average risk level of other similar exposures ran as part of the bank's core activities. Despite costs endured because of its tactical derisking strategy, Belfius Bank reports profits that are lower than peers' but improving. Derisking weighed again on net income in 2016, and we now expect the bottom line to reach a more normalized level from Belfius Bank announced a net income of 535 million in 2016, compared with 506 million a year earlier. In our view, improving efficiency and profitability is therefore the key challenge of the bank in the next two years, and the low interest rate environement prevailing in Europe does not help. We also recognize the large public finance exposures have a relatively low yield. Belfius Bank's clear focus is on its domestic market where it has good business diversification between banking and insurance services and retail and local authority clients. In our view, management executed a well-defined derisking strategy and will now focus on optimizing the bank's existing domestic strengths under cost controls. We observe that the bank is regaining more of its commercial dynamism, in areas where it already operates, in particular synergies between bank and insurance activities. We also understand the bank is trying to revive its corporate segment strategy by leveraging its knowledge of the public sector to target in particular corporates dealing with government bodies. In the meantime, we expect no transformative strategic initiatives until the bank's future ownership structure, including prospects for privatization, is clarified. MARCH 3,

5 Table 2 Belfius Bank SA/NV Business Position --Year-ended Dec (%) 2016* Total revenues from business line (mil. ) 1, , , , ,458.4 Commercial & retail banking/total revenues from business line Insurance activities/total revenues from business line N/A N/A N/A Return on equity *Data as of June 30. N/A--Not applicable. Capital and earnings: Improving capitalization We assess Belfius Bank's capital and earnings as adequate. We have observed a gradual strengthening of Belfius Bank's capital position over the past few years, and we believe it will continue. We anticipate the bank's risk-adjusted capital ratio will be in the 9.75%-10.25% range for the upcoming months, compared with 9.40% at year-end The large difference with the bank's 16.1% regulatory fully loaded Common Equity Tier 1 ratio as of December 2016 mostly relates to the higher risk weights we apply to retail exposures and insurances activities. Under this scenario, we make the following assumptions: Limited 1.5%-2.5% annual growth of the bank's commercial lending portfolio and finalization of the derisking strategy. Annual net income in the range of 475 million- 525 million in 2017, on the back of pressured interest margins, improving commission income thanks to synergies between the bank and insurance businesses, contained cost of risk (below 15 basis points), and improving modest efficiency (gradually converging toward 65% in 2017 from 68% at end-2015). An increasing dividend payout after the 75 million paid relative to 2015 net income and the 215 million dividend proposed on 2016 results, of which the bank already paid a 75 million interim dividend. For the purpose of our projections, we assume the payout ratio will remain in the 30%-40% range until end The bank's total adjusted capital (TAC) is of high quality as it consists solely of core equity. We exclude from exposure at default the amount of exposure related to insurance activities but we risk weight the amount of investment in the insurance subsidiary. Belfius Bank's investment portfolio is sensitive to credit-spread fluctuations. We expext the bank will continue to manage smoothly the gradual reduction of unrealized losses as underlying assets mature. In our view, the bank's earnings generation is gradually improving thanks to business diversification but, as with its peers, earnings are subdued by low interest rates. Depending on market conditions, this could create some volatility in the bank's results and influence the pace of reduction of deferred tax losses, which currently weigh on the bank's TAC as they are deducted from it. Like for peers, the repricing of mortgage loans put pressure on net interest revenues generated by its retail and commercial business line. This is partly compensated by cost cutting efforts and increased fee contribution from the offering of off-balance sheet investment and insurance products. MARCH 3,

6 Table 3 Belfius Bank SA/NV Capital And Earnings --Year-ended Dec (%) 2016* Tier 1 capital ratio S&P RAC ratio before diversification N.M N.M. S&P RAC ratio after diversification N.M N.M. Net interest income/operating revenues Fee income/operating revenues Market-sensitive income/operating revenues (8.7) (1.4) 22.8 Noninterest expenses/operating revenues Preprovision operating income/average assets Core earnings/average managed assets *Data as of June 30. RAC--Risk-adjusted capital. N.M.--Not meaningful. Table 4 Belfius Bank SA/NV Risk-Adjusted Capital Framework Data (Mil. ) Exposure* Basel II RWA Average Basel II RW (%) S&P Global Ratings' RWA Average S&P Global Ratings' RW (%) Credit risk Government and central banks 49,120 3, ,246 7 Institutions 24,403 2, , Corporate 33,150 20, , Retail 35,485 4, , Of which mortgage 22,725 2, , Securitization 1, , Other assets 1,496 1, , Total credit risk 144,834 32, , Market risk Equity in the banking book , Trading book market risk -- 1, , Total market risk -- 2, , Insurance risk Total insurance risk , Operational risk (Mil. ) Total operational risk -- 2, , Diversification adjustments Basel II RWA S&P Global Ratings' RWA % of S&P Global Ratings' RWA RWA before diversification -- 47, , Total Diversification/Concentration Adjustments (5,542) (7) RWA after diversification -- 47, , MARCH 3,

7 Table 4 Belfius Bank SA/NV Risk-Adjusted Capital Framework Data (cont.) (Mil. ) Tier 1 capital Tier 1 ratio (%) Total adjusted capital S&P Global Ratings' RAC ratio (%) Capital ratio Capital ratio before adjustments -- 7, , Capital ratio after adjustments -- 7, , *Exposure at default. Securitization exposure includes the securitization tranches deducted from capital in the regulatory framework. Exposure and S&P Global Ratings' risk-weighted assets for equity in the banking book include minority equity holdings in financial institutions. Adjustments to Tier 1 ratio are additional regulatory requirements (e.g. transitional floor or Pillar 2 add-ons). RWA--Risk-weighted assets. RW--Risk weight. RAC--Risk-adjusted capital. Sources: Company data as of Dec. 31, 2015, S&P Global Ratings. Risk position: Low credit risk on customer loans, but risky pockets remain in the bank's financial investments We assess Belfius Bank's risk position assessment as moderate. This reflects our view that the bank's securities remain exposed to potential deteriorating risk, and the sensitivity of assets to interest rate risk. Structurally low credit risk on the customer loan book only partly offsets this weakness. As part of its deleveraging strategy, Belfius Bank had reduced its legacy portfolio to 10.5 billion at year-end 2016 from 29.9 billion five years earlier. We consider Belfius Bank's residual exposure to Dexia S.A. to be negligible. It has materially reduced since the 44 billion exposure in 2011 with the gradual reimbursment at the end of 2014/start of 2015 of the 13.4 billion bonds issued by Dexia Credit Local and guaranteed by the Belgian, French, and Luxembourg states in the form of government-guaranteed bonds. The remaining exposures are mainly interest rate swaps that are hedged with third parties. The bank's securities portfolio is sensitive to interest rate fluctuations, mainly due to a long average maturity of 11.3 years at end In addition, the bank holds a substantial amount of derivatives ( 29.6 billion as of December 2016) with varying marked to market value that can create profit and loss volatility. Belfius Bank's customer loan portfolio is generally of very good quality. It is dominated by loans to the public and social services sectors, followed by mortgages and loans to enterprises and professionals. The share of consumer lending is rather limited. For 2017, we expect that the domestic cost of credit risk will be in the basis points range, in line with the wider Belgian banking system for this mix of credit exposures. The ratio of nonperforming loans to total loans stood at 2.7% at mid We note that the coverage of nonperforming loans by provisions is higher than Belgian peers' at 73.5%. Table 5 Belfius Bank SA/NV Risk Position --Year-ended Dec (%) 2016* Growth in customer loans (1.0) (7.2) Total diversification adjustment / S&P RWA before diversification N.M. (6.8) (7.1) (8.0) N.M. Total managed assets/adjusted common equity (x) New loan loss provisions/average customer loans (0.1) 0.4 Net charge-offs/average customer loans N.M MARCH 3,

8 Table 5 Belfius Bank SA/NV Risk Position (cont.) --Year-ended Dec (%) 2016* Gross nonperforming assets/customer loans + other real estate owned Loan loss reserves/gross nonperforming assets *Data as of June 30. RWA--Risk-weighted assets. N.M.--Not meaningful. Funding and liquidity: Improving liquidity position in line with shrinking legacy assets and reduced recourse to central bank funding We consider Belfius Bank's funding average and its liquidity position adequate. Belfius Bank's stable funding ratio stood at 95% at mid This metric is somewhat weaker than the corresponding ratio of the bank's European peers, but gradually improved from 80% in 2012 in tandem with the bank's deleveraging plan. The bank reported a 110% regulatory net stable funding ratio at end We note that, according to our computation, at mid-year 2016 core customer deposits fully covered customer loans and represent two-thirds of the funding base. The bank has also placed about 8.1 billion of bonds with retail clients, which are not included in our measure. Since 2012, the bank has been diversifying its investor base through the issuance of mortgage covered bonds, public sector covered bonds, a residential mortgage-backed security, and in May 2016 a Tier 2 note. Our assessment of Belfius Bank's liquidity as adequate reflects the bank's reduced recourse to central bank funding, declining legacy assets that generate lower short-term wholesale funding, and the bank's enhanced capacity to withstand stress thanks to a 32 billion liquidity buffer at end-2016, which enhances the bank's funding autonomy. We calculate that as of June 30, 2016, short-term wholesale funding was covered 2.2x by broad liquid assets. Belfius Bank reported a regulatory liquidity coverage ratio of 127% in 2016 compared to 109% two years before. Funding from the European Central Bank dropped massively in 2015 following the reimbursement of the funding to DEXIA Group, and we understand the bank has now replaced its TLTRO aid by TLTRO II, which we consider to be long-term funding. Table 6 Belfius Bank SA/NV Funding And Liquidity --Year-ended Dec (%) 2016* Core deposits/funding base Customer loans (net)/customer deposits Long term funding ratio Stable funding ratio Short-term wholesale funding/funding base Broad liquid assets/short-term wholesale funding (x) Net broad liquid assets/short-term customer deposits (0.4) (1.8) Short-term wholesale funding/total wholesale funding Narrow liquid assets/3-month wholesale funding (x) *Data as of June MARCH 3,

9 External support: High systemic importance but uncertain government supportwhile building additional loss-absorption capacity We believe that the prospect of extraordinary government support for the Belgian banking sector is now uncertain following the implementation of the EU Bank Recovery and Resolution Directive, including bail-in powers, from Jan. 1, We do not completely exclude the possibility of such support, and we consider that systemically important Belgian institutions such as Belfius Bank face several more years of structural and balance sheet reforms to address their resolvability (mitigating the systemic impact if they fail). Nevertheless, we think that the Belgian government's ability and willingness to provide support is lower and less predictable under the enhanced resolution framework and classify the tendency of the Belgian government to support private sector commercial banks as uncertain. We view the Belgian resolution regime as effective under our ALAC criteria because, among other factors, we believe it contains a well-defined bail-in process under which authorities would permit nonviable systemically important banks to continue critical functions as going concerns following a bail-in of eligible liabilities. However, we have not included a notch in the long-term rating on Belfius Bank because we believe that the bank's ALAC ratio will remain below 4.25% of S&P Global Ratings risk-weighted assets by end We use a 4.25% threshold for the ALAC ratio for Belfius Bank, as opposed to the usual 5.0%, because we qualitatively adjust for Belfius Bank's insurance operations, which we expect would be outside the scope of required bail-in capitalization. We calculate that Belfius Bank's ALAC ratio was 3% of our adjusted risk-weighted assets at year-end We include in this assessment Belfius Bank group's hybrid capital instruments that have capacity to absorb losses without triggering a default on senior obligations. In May 2016, Belfius Bank issued a 500 million Tier 2 instrument, and we estimate the ALAC buffer increased close to 3.6% at mid We believe that Belfius Bank's ALAC ratio will remain below our adjusted 4.25% threshold by end-2018 if we were to factor in the strengthening of Belfius Bank's capital position and revise our capital and earnings score to strong from adequate. The excess of TAC that contributes to the calculation of the ALAC buffer would reduce materially in that scenario. As such, the buffer would mostly comprise eligible subordinated instruments, which won't be sufficient, in our view, to reach the threshold. Additional rating factors: One notch to reflect the ongoing positive transition Our long-term rating on Belfius Bank incorporate one notch of uplift because we consider that the bank is in a positive transition that potentially leads to a higher capitalization or ALAC buffer in the next two to three years. This is indicated by an ongoing strengthening of the bank's capitalization ratios. We believe that the removal of this positive notch within the next months is likely as we would factor into the ratings either a further improved capital position or larger ALAC buffer. Related Criteria And Research Related Criteria Criteria - Financial Institutions - Banks: Methodology For Mapping Short- And Long-Term Issuer Credit Ratings For Banks - May 04, MARCH 3,

10 Criteria - Financial Institutions - Banks: Bank Hybrid Capital And Nondeferrable Subordinated Debt Methodology And Assumptions - January 29, 2015 Criteria - Financial Institutions - Banks: Bank Rating Methodology And Assumptions: Additional Loss-Absorbing Capacity - April 27, 2015 General Criteria: Use Of CreditWatch And Outlooks - September 14, 2009 Criteria - Financial Institutions - Banks: Commercial Paper I: Banks - March 23, 2004 Criteria - Financial Institutions - Banks: Revised Market Risk Charges For Banks In Our Risk-Adjusted Capital Framework - June 22, 2012 Criteria - Financial Institutions - Banks: Bank Capital Methodology And Assumptions - December 06, 2010 Criteria - Financial Institutions - Banks: Quantitative Metrics For Rating Banks Globally: Methodology And Assumptions - July 17, 2013 Criteria - Financial Institutions - Banks: Banks: Rating Methodology And Assumptions - November 09, 2011 Criteria - Financial Institutions - Banks: Banking Industry Country Risk Assessment Methodology And Assumptions - November 09, 2011 General Criteria: Group Rating Methodology - November 19, 2013 Guarantee Criteria October 21, 2016 Related Research Belgian Belfius Bank Outlook Revised To Stable; 'A-/A-2' Ratings Affirmed November 10, 2016 Banking Industry Country Risk Assessment: Belgium August 17, 2016 Anchor Matrix Industry Risk Economic Risk a a a- bbb+ bbb+ bbb a a- a- bbb+ bbb bbb bbb a- a- bbb+ bbb+ bbb bbb- bbb- bb bbb+ bbb+ bbb+ bbb bbb bbb- bb+ bb bb - 5 bbb+ bbb bbb bbb bbb- bbb- bb+ bb bb- b+ 6 bbb bbb bbb- bbb- bbb- bb+ bb bb bb- b+ 7 - bbb- bbb- bb+ bb+ bb bb bb- b+ b bb+ bb bb bb bb- bb- b+ b bb bb- bb- b+ b+ b+ b b+ b+ b+ b b b- Ratings Detail (As Of March 3, 2017) Belfius Bank SA/NV Counterparty Credit Rating A-/Stable/A-2 Certificate Of Deposit Local Currency A-/A-2 Junior Subordinated BB+ Senior Secured AAA Senior Secured AAA/Stable Senior Unsecured A- MARCH 3,

11 Ratings Detail (As Of March 3, 2017) (cont.) Short-Term Debt A-2 Subordinated Counterparty Credit Ratings History 10-Nov Apr Dec-2011 Sovereign Rating Belgium (Kingdom of) BBB- A-/Stable/A-2 A-/Negative/A-2 A-/Watch Neg/A-2 AA/Stable/A-1+ *Unless otherwise noted, all ratings in this report are global scale ratings. S&P Global Ratings credit ratings on the global scale are comparable across countries. S&P Global Ratings credit ratings on a national scale are relative to obligors or obligations within that specific country. Issue and debt ratings could include debt guaranteed by another entity, and rated debt that an entity guarantees. Additional Contact: Financial Institutions Ratings Europe; FIG_Europe@spglobal.com MARCH 3,

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