ETHIAS : We confirm our Buy recommendation, pending upgrade of the 2026 to IG

>Strengths/Opportunities - - Ethias is Belgium's fourth-largest insurer, all segments combined, with a 9% market share, and the leading insurer of the public sector and its agents. It is the third-largest non-life insurer, with a market share of 11%, and the fourth-largest life insurer with a market share of 7.4% (source: Assuralia 2016). - Ethias is the only major direct insurer in Belgium, where brokers and bancassurers have a predominant position.- It is the special partner of local authorities. Ethias is the natural insurer of public authorities. - Technical results in non-life insurance are solid, reflected in a combined ratio of below 100%.- After providing several exit routes for policyholders, Ethias will remove its First A portfolio from its balance sheet by the end of the year, as the sale contract with Laguna Life, a subsidiary of Monument Re, was signed at the end of April. Solvency gains have already been achieved and the group will become less sensitive to interest rates going forward. - The end-2017 solvency ratio using the standard formula and without transitional measures was 204.5%. It enables the group to pay € 268m in dividends to Vitrufin (€ 150m was already approved at the AGM on 16 May and an interim dividend of € 118m is due to be paid in H2 2018) to repay the senior bond due in January 2019. The post-dividend solvency margin remains comfortable at 183%, comfortably topping the 150% target set by the group.Weaknesses/Threats - - Despite the exit from First A contracts, payment of the guaranteed returns on life insurance contracts remains high at 2.78% on average in the retail life insurance business and 2% in the group life insurance portfolio, compared with the potential return of a portfolio that is predominantly invested in core country sovereign debt in periods of low interest rates. - Business concentration in Belgium, a mature and fierce competitive market which has been experiencing contractions in life insurance and limited growth in the non-life segment.Credit opinion: positive; market recommendation: Buy - Ethias saw a number of credit-positive developments in 2017 such as the end to the EC restrictions that the group had to abide by since 2008, the scheduled exit from First A contracts, the shareholders' agreement to a two-year standstill period, a repayment solution for the Vitrufin bond, and lastly an upgrade to 'BBB+' by Fitch. At the same time, profitability stabilised and solvency improved significantly. On balance, listing the criteria required by Fitch, we believe Ethias is highly likely to receive another one-notch upgrade. As for the timescale, the agency may wait until the actual repayment of the Vitrufin bond to do so and could therefore highlight the strong 2017 earnings results and the solution found for the Vitrufin repayment by an initial positive outlook when it reviews the credit in June 2018. We are therefore upgrading our credit opinion to positive vs. stable. For the 2026 bond, that would mean an upgrade to IG status (from 'BB+' to 'BBB-'). The price/spread of the Ethias 2026 has already partially factored in this expectation, since the 2.8% yield is close to that of Groupama 2027 (3%) which is already rated 'BBB-'. Still, we believe this positive trend will underpin the bond's performance in the months ahead and reiterate our Buy recommendation.