ING : Strong fundamentals and continued successful strategy; Buy Tier 2 3% 2028/23

ING is a strong credit. Its 2017-2020 strategic plan, presented last October, follows on from the 2014-17 plan. ING's earnings releases confirm quarter after quarter the relevance of its strategy and its successful implementation, resulting in robust and recurring earnings generation and enhancing its key credit indicators. We are upgrading by one notch our ratings on ING Bank and ING Group to 'A+' and 'A' respectively (Outlook stable). The main source of uncertainties is not ING-specific but concerns the entire banking sector with the review of the Basel rules and their impact on capital requirements, potentially business model. The conclusions made public on the Basel Committee meeting held on 28th and 29th November do not clarify the extent of the reforms (dubbed ‘Basel IV’), in the absence of agreement between parties. - As ING announced during its 3Q16 results, the group’s holding company ('ING Groep NV', ING Group) will likely be designated as its resolution entity. Once confirmed by the European authorities, this would pave the way for ING Group to issue TLAC eligible senior debt, mirroring UK and Swiss banks, probably during H1 2017. - We have assigned a Buy recommendation on the Tier 2 2028/23 3% subordinated debt securities (YTW 2.43%, ASW 216bp) issued by ING Bank in April 2016. The securities include an issuer substitution option whereby, until April 2018, the issuer can be replaced by ING Group. The premium related to this option seems generous (ASW difference +50bp vs. ING Bank Tier 2 2026/21); in our opinion, a substitution would not increase subordination of the instrument, and thus the associated risk. We reiterate our Neutral recommendation on the other instruments issued by ING Bank and ING Group which offer yields in line with those of securities issued by similar rated banks and for which we do not expect outperformance. - >Support factors - - The group's geographical and operational diversification underpins its solid credit profile by giving it little dependence on the performance of any single jurisdiction or activity and access to a broad customer base. Its challenger positions in mature markets and presence in emerging countries provide growth engines that adequately complement its dominant positions in Benelux.- ING's asset quality is sound and risk management is adequate; the NPL ratio is low (2.2%). The share of residential property loans (51% of customer loans in the year to end-September 2016) is decreasing, in line with ING's strategy, but set to remain predominant.- ING has solid capital ratios (fully-loaded CET1 of 12.6% and 13.5% for ING Bank and ING Group at the end of 9M 2016) supported by consistently robust profitability and good internal capital generation, despite the resumption of dividend payments since 2014. We expect the impact of the regulatory changes on capital ratios to be reasonable for ING.Points to watch - - Profitability could be negatively impacted by a prolonged low interest rate environment and net interest margin would decline from 2018 in such an environment. In addition, regulatory charges (banking taxes, allocations to deposit guarantee and resolution funds) represent a drag on the profitability of the group and that of its peers.