Arion banki hf

ICEX:ARION

Earnings Call Transcript 2022-Q1

[Benedikt Gislason, executive]

Good morning, and welcome, everyone, to this earnings call of Arion Bank's financial results for the first quarter. It's good to see so many attendees here today. [Operator Instructions]

The agenda for this call is that I'll start by going over the highlights of the quarter. Our Chief Economist, Erna Björg Sverrisdóttir will then address the current macro situation and probably in the context of yesterday's 100 basis points policy rate hike. And finally, Arion's CFO, Olafur Hrafn Hoskuldsson, will go into the numbers in more detail.

But it's fair to say that the -- that Arion Bank's financial results in the first quarter were good and in line with our financial -- medium-term financial targets. Operating income increased by 11% year-on-year, mainly due to net interest income, which grew by 9% in the quarter. There was also a strong insurance premium growth, but it was a difficult quarter in terms of claims.

And the loan growth was quite robust in the quarter, especially on the corporate side, and I'll spend some time discussing that in more detail. And finally, on our capital release program, we released more than ISK 26 billion, almost ISK 27 billion in the first quarter to our shareholders through dividend -- normal dividend and the buyback program.

Now we've made some recent and broad management changes, leveraging on our in-house talent and cooperation. And the idea is, obviously, to increase the cooperation across the organization. Firstly, I would like to welcome Ida Brá Benediktsdóttir to a new Deputy CEO role. She has worked for the organization since 1999 and brings loads of experience from various divisions to the table. This promotion also reflects that bancassurance within retail banking is a key strategic initiative for us. Our new head of CIB comes within that team, the CIB team, and leadership changes in markets, Stefnir and compliance also came from within the group.

Now to loan growth and our CIB strategy. And I think it's fair to say that over the past couple of years, we've made really good progress with the change in business strategy for our corporate investment bank, with focus on capital velocity, revenue on top of risk exposure amount, and our role as an intermediary in the financial markets.

And this slide illustrates an interesting statistics where over the past 2 years, since first quarter of 2020, we have grown our corporate book by some ISK 37 billion. But at the same time, we have syndicated and sold ISK 36 billion of loans to other investors. And that is a key pillar to our success in growing the revenue on the risk exposure amount for this division, which has the highest proportion of the risk exposure amount and has considerably improved our profitability.

At the same time, we have made advancements with our Arctic region strategy where the portfolio has almost doubled in size over the same period. And a bulk of the loan growth in the first quarter actually came from new lending outside of Iceland but in the Arctic region in sectors or industries that we have expertise in. And we think that this is -- this will improve our diversification of credit portfolio and should reflect in a better kind of risk profile for the bank.

Now we made some progress as well with our green loan book. We have made an internal target of doubling the -- sort of have a double growth rate of that book compared to the growth of the total loan book. And you can see that this is now close to 14%, both on the financing side and on the asset side. And we tend to grow this, as I said, twice as fast as the loan book.

Now this is a new slide into the deck from an announcement yesterday. So we're very pleased to announce -- tell you about our -- an agreement that we are signing with Mosfellsbær municipality on the development of the land of Blikastaðir. Blikastaðir is the largest unexplored residential real estate development plot in the capital area. It's more than 90 hectares in size. And the agreement anticipates between 3,500 and 3,700 residential units and, obviously, a large commercial real estate area as well, along with schools, kindergartens and sports centers, where actually Arion is committing to participating in the cost of the construction of the necessary infrastructure. We're hoping to be able to give you more detail on this in the very near future.

On our assets held for sale, which is a line below the kind of -- at the bottom of our income statement, which is something that we intend to eventually remove from our income statement. So on Valitor, as you can read from the ICA web page, the matter is still being discussed with resolution or result expected in the coming days. As you saw from our announcement, we have increased the purchase price by negotiating with Rapyd, the acquirer of the asset. And the expected windfall from the sale is now ISK 5 billion, and the release of capital around ISK 9 billion that we hold. Sales proceed is effectively distributable and will not impact our capital ratio at all. But the release of capital is the windfall and then the part of the purchase price which is intangible equity.

And speaking of ICA, we received an approval by the ICA or resolution on a merger of Heimsferðir, which is a tour operator that we acquired through a debt restructuring. And we obviously do not intend to be in the travel business and foresee these assets to be asset to be sold in the near future.

So that concludes my part of the presentation, and I welcome Erna Björg Sverrisdóttir, our Chief Economist, to the podium.

[Erna Sverrisdóttir, executive]

Thank you, Benedikt. Good morning, everybody. It's great to be with you all here today. The world has certainly changed since the last time I stood up on this stage, as are the economic conditions. So we have a lot of catch-up on, only a few minutes, so I promise I will try to be brief.

The first quarter of 2022 was eventful to say the least. The pandemic took the nation on a rollercoaster ride, as in January, restrictions and gatherings were tightened, almost all events were canceled and the nightlife closed. But just 1 month later, all restrictions, both domestically and at the border, were lifted. And actually, Iceland is well on its way to reach herd immunity, a fact that has received little attention as the focus has almost completely shifted from COVID to the war in Ukraine.

So far, the direct effects of the war are limited, mostly contained to the seafood industry. Of course, this is a heavy blow for certain companies as important market areas for pelagic fish, used fishing vessels are closed. But looking at the bigger picture, compared to the Icelandic economy as a whole or the country's foreign trade, the impact is relatively small. In 2021, just 2% of total exports of goods went to the affected market areas. And also now, a record high production prices have softened the blow to the seafood industry.

And this is one of the byproducts or side effects of the war, the sharp rise in commodity prices. And of course, this affects Iceland, we are a small open economy and we are dependent on foreign trade. But let's not forget that Iceland is a commodity exporter, mainly through seafood and aluminum. And this means that despite higher oil and commodity prices, the country's terms of trade have not deteriorated, quite the opposite in fact.

However, rising commodity prices, high inflation among the country's main trading partners and just the fact that there is a war raging in Europe could have significant effect on the economy through the tourism industry. It is getting more expensive to fly to the country. And households, both in the U.S. and Europe, are facing a large income squeeze, which could negatively affect the demand for travel.

So far, the war has not had any visible effect. As in the first quarter, the tourism industry went from strength to strength, with over 100,000 tourists visiting the country in March. And I am fairly optimistic for this year, in my opinion, Iceland is still a dream destination. It is one of the least densely populated country in the world. It's pretty easy to get here. There are 75 summer destination scheduled, the same number as in 2019. But most importantly, Iceland is the most peaceful country in the world and has been for over a decade.

So we have not changed our view despite the war and still anticipate that 1.6 million tourists will visit the country this year. In addition, each tourist is spending more than before, at least compared to 2018 and '19, a development we expect to continue throughout the year.

Now the tourism industry, it is a labor-intensive sector. So the industry's recovery has provided considerable support to the labor market. But tourism isn't the only sector that is hiring, actually far from it. Jobs have increased cross-sector and the economy, as a whole, has recovered all the jobs lost in the pandemic. Of course, it's not the same jobs, but it is the same number. And the fact is the situation on the labor market has exceeded all expectations.

Even though many employment subsidies provided by the government expired in the first quarter, unemployment rate remained steady and even below 5% in March. So we are at pre-pandemic levels much sooner than anticipated. An improved employment outlook coupled with rising house prices and real wage growth, which, yes, was still positive in March despite 6.7% inflation, have laid the foundation for a strong private consumption.

For example, in the fourth quarter, private consumption increased by a whopping 13% between years, the highest growth in a single quarter since 2005. And in the first quarter, we have -- of this year, we have continued to see record-breaking payment card turnover figures as Icelanders are spending more than ever abroad. So overall, the economy is set for a strong growth driven by tourism, private consumption and business investment with the consensus among domestic analysts at 5% GDP growth this year, followed by a 2.8% GDP growth in 2023.

Now although the outlook, as you can see here, is pretty bright, that doesn't mean that this year will be easy, actually far from it. We are facing some major challenges, which could easily overthrow all of these economic forecasts. First of all, house prices have risen sharply. In the first quarter, house prices in the deck here increased by 22% between years. And in March alone, house prices increased by 3.1% between months.

And at the beginning of the cycle, price increases were driven by rate cuts, but now a housing shortage plays a more prominent part. And in fact, at the end of the first quarter, just under 500 properties were advertised for sale, which is the lowest number ever recorded. So despite significant wage increases in January, house prices have risen at a considerably quicker rate than both wages and especially disposable income over the past 2 quarters, leading to a growing imbalance in the housing market.

And currently, house prices are the main driving force behind inflation. In April, inflation measured 7.2%, so well above the Central Bank's 2.5% inflation target, and almost half of it can be attributed to house prices. This is a very different situation from other European countries where energy costs have kindled inflation.

Now at the same time as house prices are soaring, domestic inflationary pressures are increasing and imported inflation is on the rise. And in this context, I think we have just seen the tip of the iceberg. Thus, most analysts expect that inflation will remain between 7% and 8% over the coming months, even peaking above 8% according to the Central Bank's latest economic forecast before it starts to trickle down again, but stays above the inflation target for the next 2 or 3 years.

Now this persistent inflation, rising house prices and fear over de-anchoring of inflation expectations have compelled the Central Bank to raise interest rates by 300 basis points since May last year, with 100 points announced yesterday. Further rate hikes are expected as early as June. This is a tricky situation that we find ourselves in because at the same time as the Central Bank is tightening the monetary policy, the government is running an accommodative fiscal policy. So it kind of feels like the Central Bank is going one way, the government another. And then to top it off, we have the labor market with very difficult wage negotiations ahead of us.

So as I said, it won't be easy, but if we play our cards right, it just might work. That being said, I would like to welcome Olafur Hoskuldsson, our CFO, to the stage. Thank you.

[Olafur Hoskuldsson, executive]

Thank you, Erna. Good morning, all. So as I normally do, I want to start off by summarizing the key takeaways from this quarter's results. And first of all, of course, a very solid 12.7% return on equity. And this is underpinned very pleasingly with core income, which is increasing by 16% year-on-year.

Secondly, the key theme for this quarter is the 8% increase in net interest income, and the net interest margin which is increasing to 3.1%. And this is driven by a combination of a robust growth in corporate lending and a positive shift in our funding costs as well as, of course, the increase in policy rates.

Third, in terms of the loan growth, we saw the total loan book grow by 4.3% in the quarter. This is driven by 8% growth in the corporate loan book. The pipeline there remains very strong. And importantly that remains strong both on the origination and syndication side, and I'll discuss that further later.

Fourth, while we continue to make good progress in the bancassurance project, our key -- our -- the insurance business had a difficult quarter, especially in terms of claims. The fee business, however, continues to be very strong, and we saw a solid -- we see a solid pipeline across the bank -- across the group in terms of these generation. Enhanced fee generation and the net insurance business continues to be a key strategic project for the group.

And finally, during the quarter, we paid out a dividend of ISK 22.5 billion to our shareholders. And this follows a shareholder distribution of just under ISK 36 billion over the past year. We ended the quarter with a Common Equity Tier 1 ratio of just over 19% and continued to move towards our target, which continues to be 17% ratio.

So looking more closely at the results. So net earnings were ISK 5.8 billion in the quarter compared to ISK 6 billion last year. The contrast importantly is that core income increased by 16%, which is the driver for this -- the current quarter's results. As said, that is -- we had this 16% increase despite what was a very difficult quarter in the insurance business. We've delivered only a ISK 5 million net insurance income versus ISK 671 million last year. And I'll discuss that more later.

And I will discuss the key line items in more detail on the following pages. But as you can see on this page, the interest income was a key driver in this quarter, and -- as well as the continued momentum in our fee generation.

In terms of impairments, there is a contrast to last year's first quarter results, where we had a ISK 1 billion positive reversal of impairments. This quarter, we have a ISK 500 million impairment, and this relates to effectively a cautious view on the potential secondary impact of the war in Ukraine. And I'll go further into that on later pages.

So looking at net interest income, specifically. This increased, as said, by close to 30% compared to the first quarter of last year and 8% from the last quarter. The net interest margin rose to 3.1%, up from 2.8% level, which has been relatively steady over the past quarters. So the key -- the increase is driven, of course, by the sharp increase in policy rates, which increased by 75 basis points in February and now, of course, yesterday, increased by another 100 basis points.

An important other catalyst was the growth in corporate lending, which largely drove the increase in credit risk by ISK 44 billion in the quarter and almost ISK 100 billion over the last year. Generally, of course, these loans have a higher contribution to net income but of course, at the same time, tie up more capital versus mortgages.

The final key driver for the improved net interest income is the composition of our funding. Over the past year, we have seen borrowings increased by roughly 20%, while net interest on those borrowings were roughly flat. The result of the refinancing in a low interest rate environment as well as the composition, which was driven, of course, by the euro covered issuance over the past year, has meant that their funding cost -- average funding cost has come down.

So looking ahead, we see the further policy rate hikes and the strong lending pipeline as being supportive of our NIM going forward. But at the same time, we are cautious as to the rate environment on the funding side. And we generally see the impact of rates -- rate hikes hit the asset side of the balance sheet before it hits the liability side. It is, therefore, very difficult to make a clear guidance as to the overall rate sensitivities in the current environment. We will, of course, continue to monitor that and hopefully have a better view later in the year.

So in terms of net fees and commissions, which continues to be a very strong positive for the group. Net commissions for the period was just over ISK 3.5 billion. While this is slightly below the last 2 quarters, we continue to see a very strong momentum in the last -- in the fee generation. As Benedikt mentioned earlier, the syndication part of the CIB business has become a staple of the strategy of that business, and that has allowed for increased origination and internal fee generation.

Another part that's worth mentioning of fees is -- that the proposed sale of Valitor has the added impact of when that gets completed to increase fees by around ISK 200 million to ISK 450 million per quarter. So these are fees that allow to effectively pace through our impact, and today are lost in consolidation. So when the Valitor becomes a third party, that comes into our card fees going forward.

So looking at the insurance business which, as said, had a very challenging quarter. So historically, the first quarter of the year has been a difficult one for Iceland insurance companies, as you can see on the top left chart on that page. The past 2 years, of course, have been very much impacted by the COVID pandemic, so the activity of our clients has been reduced.

So now we are seeing more of a normalized trend where the first quarter is a difficult one for insurance companies. But then we had added to this, this year, with a very difficult quarter in terms of harsh weather conditions in Iceland. And the result overall was a 40% increase in claims year-on-year, and one of the highest claims ratios, unfortunately, that we've seen for a few years.

On the positive, we continued to see momentum on the premium growth, with a 10% increase from the first quarter last year. And we can also see that the cost ratio is reduced somewhat. And although it is early days in our bancassurance project, the aim is for this to continue to come down as we leverage our synergies across the bank and across the group.

But obviously, on the positive, paying claims is a key part of an insurance company's business. And -- although this quarter -- in this quarter, this activity was higher than anticipated, this gives us an opportunity to interact with our clients and utilize our strong connections within the bancassurance project. So it's an important time to interact with our clients and make a good impression, which is a positive.

So in terms of net financial income, we, of course, had a very volatile quarter. There was a difficult beginning of the quarter, but it was then turned around somewhat at the end of the quarter. The net result was a financial income of just under ISK 1 billion with the insurance company contributing ISK 332 million out of those.

In terms of operating expenses, there's generally not much to highlight here. We see operating expense of ISK 6.2 billion and a cost-to-income ratio of 42.7%. At the start of the year, we moved all of Valitor's employees into our headquarters here, and that's now been successfully completed. This continues to further create efficiencies in our housing costs, which have, of course, been reduced considerably over the past years.

In terms of salaries, our fixed -- average fixed salary increased by 3% versus the same time last year, which is still tracking well below the salary index in Iceland, which rose by around 7% in the period. And we continue to manage this, of course. And clearly, our incentive scheme, which we highlighted earlier, is an important part of that management effort.

Finally, at the year-end results, we presented plans for specific investments which we had earmarked for up to ISK 1 billion over the coming year. This continues to be very much the plan, but we are managing the timing of this somewhat more closely now with the enhanced uncertainties in the external environment and the war in Ukraine. We do anticipate that some of these investments will slightly now to spread into the next year.

The key aim, of course, is to continue to drive efficiencies across the business as well as managing general inflationary pressure in the economy. The aim is, of course, not to eliminate costs and our business is, of course, very reliant on having smart people, strong systems to support our client service and decision-making and risk management. And we, of course, aim to excel in these areas so that investment plan is intact.

Now moving on to balance sheet. The key themes over the past year in terms of robust lending supported by strong deposit inflows has effectively continued this quarter. The loan book grew by 70% in the past year, while deposits have grown by 14%. And I will discuss these in more detail on the following pages. Our liquidity and stable funding position continues to be very strong with an LCR of 195% and a net stable funding ratio of 112%.

So in terms of the loan book, following a couple of years where mortgages drove the growth in our loan book, we saw a shift in that at the end of last year. For this quarter, we then saw corporate lending grow by 8% while loans to individuals grew by only 1%. The result is an overall 4.3% in the loan book. There are a few things to highlight here.

Firstly, we have, in recent months, seen market pricing in terms of fixed rate mortgages that have, in our view, not been appealing. As we did with corporate lending in 2019, we aim to be very stringent when it comes to pricing -- our pricing strategy. And this then will impact our market shares during the times when we see somewhat unsustainable pricing in markets.

Secondly, because we did not grow our corporate loan book in 2019 and '20, mortgages are a higher share of our loan book than for key competitors, which provides scope for us to grow in corporates within what we see as optimal lending mix framework. We currently have 55% of our loan book to individuals, which was 48% at the end of 2019. Our position remains flexible, and we anticipate that over the medium term, growth will align between the 2 sectors and that the mix will continue to be around the 50%, 50% level.

We do also anticipate that growth on the corporate side will be slower for the rest of the year. This is partly already known as we have in place agreements for sales of some of the originated loans that came into our balance sheet in Q1. Again, the diversification of our portfolio remains very strong, both in terms of individuals, corporates and within sectors of corporates. In recent months, we have also diversified further into the Arctic region, as Benedikt mentioned earlier.

Very quickly on the asset quality in the loan book. We generally continue to see a positive outlook. We did, however, as mentioned, increased the loss allowance slightly this quarter. This mainly relates to potential secondary impacts of the war in Ukraine and affected mainly our stage 1 assets. And this is effectively us stressing our IFRS modeling in our provisioning. The loan loss provision stands at 0.8% of the loan book. We continue to guide towards around 20 basis points normalized cost of risk based on our current loan book composition.

So growth in deposits has been a key theme for the past year and the growth continued this quarter. Growth in core deposits was 4% in the quarter compared -- following a 22% growth over the past year. We continued to see opportunities to be competitive in attracting deposits, while rising rates, and potential crowded ISK funding markets will continue to drive competition in this area.

So in terms of borrowings, we opportunistically tapped our euro covered bond in March with a EUR 200 million issue. We took that issue to a benchmark size of EUR 500 million. During the past few months, we have also redeemed [ 13 billion ] of senior unsecured in Swedish krona and Norwegian kroner. As we previously discussed, the covered bond issue -- the euro covered bond issue was a very important diversification for our funding profile.

Again, this has been demonstrated in recent months. When following the Ukraine war, many of the -- our funding markets became somewhat dysfunctional and spreads widened. The impact on the euro covered market was much more muted than for the senior unsecured market, for example. And this demonstrates the support that this funding option has given us. We have also been active in the domestic market. We issued a total of ISK 9 billion in this quarter in green senior preferred and covered bonds.

Finally, in terms of the MREL requirements, we have now received the final requirements from the regulator. And effectively, the conclusion is that we meet those requirements even with our optimized capital level. As discussed, the subordination requirement is not expected until 2024, whereby we estimate a potential small requirement for a nonpreferred issue based on our optimized capital level being reached by that time. We are, however, opportunistically reviewing the senior nonpreferred market, and we could potentially issue earlier based on potential positive ratings impact.

In terms of capital, we paid out a ISK 22.5 billion as discussed dividend in the quarter after almost ISK 36 billion of shareholder distributions over the past year. Our capital position remains very robust, and we continue to work towards the optimized capital level of 17%. Including the assumed 50% dividend payout ratio, we now have a roughly ISK 18 billion surplus capital position or 2.1% of risk exposure amount. This excludes, as discussed, the anticipated Valitor impact, which is around 1.5% of risk exposure amount. Leverage ratio, of course, remains very strong at 12.5%.

So going forward, first, we continue to be in a very strong position. Our operations continue to strengthen across our businesses and the pipeline and strategic position further supports our earnings outlook. The increase in net interest income seen in the quarter further supports our pillars of the business, which has been strengthened in recent quarters by the fees and insurance business as well. We are seeing, of course, a fast rise -- faster rise in policy rates than we have seen for a long time. This is boosting our net interest margin fast, and this will support our interest income going forward.

We do, however, cautiously anticipate that rate sensitivity will slow as we move further into the year. It is difficult, however, as discussed, to guide to this at the current time because things are happening very fast, but we will provide more clarity later in the year. While the growth in mortgages has slowed for the time being, we are seeing strong opportunities on the corporate side as discussed. It is a testament to the diversity of our business that we can utilize these opportunities and move our growth between areas where we see the most potential.

A key part of facilitating in the ongoing balance in the housing market, moving to what Benedikt mentioned earlier, is to support the supply side of that market. To that end, we are very pleased with the good progress that is being made in negotiations and, hopefully, an agreement today with Mosfellsbær municipality for development of over 3,500 residential units in the capital area.

The CIB strategy of capital velocity is working well and is allowing the business to originate 2x the amount has allowed over the past year, 2x the amount of loans that ended up on our balance sheet. This is -- this productive cooperation with investors further supports our business going forward.

The tragic war in Ukraine added, of course, a new risk to the external environment in the quarter. The primary impact, as somewhat mentioned by Erna, is limited to our clients, but the secondary effect, of course, will be monitored carefully. Inflation, of course, is the key global risk that's facing our clients. A key milestone in how Iceland, of course, will be able to manage this risk going forward will be around the union wage negotiations in the autumn. It is, obviously, very important for the balance of the economy that these negotiations have a sustainable outcome.

And finally, we see the group as staying in a strong position to navigate the ever-changing operating environment. We have a diversified revenue base, robust balance sheet and a clear strategy.

Thank you. And I would now like to hand over to Q&A, introducing our Head of IR, Theodor Fridbertsson, who will manage the questions.

[Theodor Fridbertsson, executive]

Thank you, Olafur. I think we'll start with questions submitted through the online platform. So our first initial sort of questions, if we start with the loan book, how does the bank see the loan book developing in the near future? I mean, obviously, we are disclosing sort of a strong pipeline in the corporate book, but how would you foresee it sort of through the year?

[Benedikt Gislason, executive]

Yes. Maybe to start with, obviously, our financial target is to see the loan book grow in line with nominal GDP growth. And based on current inflation and GDP forecast, that's almost a double-digit number.

[Erna Sverrisdóttir, executive]

10% to 12%.

[Benedikt Gislason, executive]

Yes. So -- but based on kind of the growth in the mortgage space at the moment, we're probably tracking slightly below that at the moment.

[Olafur Hoskuldsson, executive]

Yes. I mean I think we're tracking probably in line with given the strong growth on the corporate side. But I think just as I mentioned, the mortgage side probably is going to be below where we anticipated maybe a year ago. But on the corporate side, we are seeing our clients, things are not all gloomy. I think there's activity on the corporate side.

We are seeing -- as Erna mentioned, we are optimistic around the tourism sector coming back. This is creating a lot of activity on the corporate side. So I think we continue to guide where we -- our previous guidance.

[Benedikt Gislason, executive]

And we continue to find opportunities in the Arctic as well, have kind of a nice pipeline of potential kind of loans to originate and some, hopefully, to syndicate as well.

[Theodor Fridbertsson, executive]

Then the next question also regarding the loan book. Obviously, we spoke about the sort of syndication progress. And the question is what are the bank's expectations regarding further syndication of loans?

[Benedikt Gislason, executive]

For this to continue and the market to grow. There's really good appetite with a broad range of investors -- institutional investors. It's not only kind of isolated to the pension system. And some of these syndications that we've done, we've done with international parties. And that kind of -- that market seems to be opening up further.

[Olafur Hoskuldsson, executive]

I think this all -- from the 2019 Capital Markets Day, this was our strategy. This wasn't sort of traditionally the way things were done in Iceland. But this -- part of this strategy was also looking at syndication from the start. So when we structure loans, thinking about structuring them with syndication in mind and having an open dialogue through the origination phase with investors.

And this has been driving this to a degree as well. This is also a matter that we have from a stock of potential syndicate -- loans that could be syndicated further, which are sort of structured in a way that they can very easily be sold, and that's up to -- probably up to ISK 100 billion in loans that could be sold.

[Theodor Fridbertsson, executive]

And the third loan book question is what is causing the increase in impairments? And what kind of loans are being revised down? Maybe Olafur, I mean you gave a color on the stage 1 development.

[Olafur Hoskuldsson, executive]

Yes, I think that probably answered it. I mean this is basically us sort of stressing our models and incorporating some of these sort of uncertainties related to Ukraine. So there's nothing really specific. So it's mostly hitting, sort of, in the models hitting the corporate side.

[Theodor Fridbertsson, executive]

Then we have a couple of questions regarding the insurance business. What are the bank's expectations regarding the combined ratio for the full year? I mean last year, the combined ratio was just north of 93%. And how do we foresee that developing?

[Benedikt Gislason, executive]

I think our expectation is that this was an unusually difficult quarter. So normally, things improve over the year within -- in Icelandic insurance companies. So without giving a number, I think we continue to target a ratio sort of well below what we're seeing now. I think we're not guiding to anything else. It's hard to predict weather conditions on this island.

[Theodor Fridbertsson, executive]

And what was the growth in number of policyholders been over the last 12 months? And that number is -- I can disclose that, that number is 3%.

Then we move on to questions from Maria from Citi. How much of the 200 basis point rate hikes were passed through the loans and deposits -- well, have already been passed through loans and deposits?

[Benedikt Gislason, executive]

Olafur, do you want to answer that?

[Olafur Hoskuldsson, executive]

Yes. I mean -- in terms of our loan book, I mean, I think almost 70% of it is in floating rates. Most of the corporate loan book is floating rate. I think we have only 15%, 16% which is fixed in our total loan books, that's mostly the mortgages -- fixed mortgages. So that's why I say sort of things pass quicker through the asset side of the balance sheet. It happens very quickly. We also have ISK 100 billion of liquid assets, which is effectively repriced almost straight away.

On the deposit side, we have been increasing the savings accounts steadily. I don't have a sort of a number, how much of that has been passed through yet on average.

[Benedikt Gislason, executive]

Deposit margin has definitely come up in the industry. But the question now remains whether there's going to be increased competition for deposits, we'll narrow it back. So as Olafur explained this, the liability side tracks this probably slower than the asset side, especially when you have most of the asset side on floating rate terms.

[Theodor Fridbertsson, executive]

Yes, I think we can also mention that the 75 basis point hike previously, it does not fully sort of come into place as the rate hike from the Central Bank was in February. So that did not sort of affect the full quarter.

Then second question from Maria, at what levels of interest rates do you see material risk to your growth outlook in line with nominal GDP and asset quality? So 20 basis points normalized cost of risk -- referring to the 20 basis points normalized cost of risk.

[Olafur Hoskuldsson, executive]

This is a very good question, Maria. I think Erna, previously, we were expecting policy rates to normalize at 4.5%?

[Erna Sverrisdóttir, executive]

Yes, 4.5%. But after the last rate hike yesterday and the latest forecast from the Central Bank showing the output gap and inflation going forward, probably around 5%. We're seeing interest rate normalize in maybe 1 year, 1.5 years before coming down again.

[Olafur Hoskuldsson, executive]

Yes. And in that scenario, 4.5% and even 5%, we did not anticipate any kind of material impact to the loan quality of the book, especially if the economy is tracking where we expect it to be. But it's obviously subject to many kind of different components, like the wage agreements in the fall and cost items or input prices for our clients, and their ability to pass through cost increases to their products. But currently, we -- this is -- obviously, if interest rates move dramatically, this will become a big issue.

[Theodor Fridbertsson, executive]

And then the final question from Maria, regarding the Arctic lending, how do margins and cost of risk in the Arctic lending compare to domestic lending -- domestic operations?

[Olafur Hoskuldsson, executive]

Yes. Maybe just to start by sort of going through the capital impact. So we have slightly less capital deployed to this as one of the buffers is not used for international lending. I mean there is similarity in -- even though these are different countries, there is -- there are some common themes when it comes to these industries.

Seafood industry remains pretty much the same, even though there are different species being fished in the ocean. But the margins are slightly better and less capital deployed against the loans. So there is headroom for, sort of, slightly higher cost of risk, obviously, on net lending. But I would say that the cost of risk in those sectors that we are focusing on remains similar to the cost of risk of those same sectors in Iceland.

[Theodor Fridbertsson, executive]

Then we move over to questions from Rahul from Tellimer. Would Arion consider acquisition to accelerate the Arctic growth strategy?

[Benedikt Gislason, executive]

I think we're looking at this holistically, this opportunity. And we've looked at different options, there is no decision.

[Olafur Hoskuldsson, executive]

No.

[Benedikt Gislason, executive]

The current strategy is working well. Organically going into those markets, having a slightly different proposition than the local presence, and we've been able to grow well with that strategy.

[Olafur Hoskuldsson, executive]

As -- while we continue to find interest for our services without having kind of physical presence in those locations, we -- I think this is a good way of learning more about these economies and getting to know the business community. And the -- obviously, I think what we have to bring to table in countries like Faroe Islands and Greenland is the fact that the banking systems there are small and somewhat less developed than in Iceland. So there is the ability for us to get involved with companies that have outgrown the banking system in these countries. And to an extent, the same applies for the East Coast of Canada and Alaska.

[Theodor Fridbertsson, executive]

And then moving back to the interest rates and sort of the cost of risk. Given that interest rates are rising sharply, do you expect to see some borrowers' stress emerging later this year?

[Olafur Hoskuldsson, executive]

We've done a number of stress tests on our mortgage portfolio. And there are no -- still no indications of stress or sort of borrowers' stress yet. And if you look at the kind of the debt service as a ratio of net disposable income, it's still relatively low from a historical standpoint. And many of kind of mortgage borrowers have fixed their mortgages for 3, 5 years, even though our kind of participation in the market has been somewhat lower than our market share is.

And then there is always the alternative of moving to CPI-linked longer maturity mortgages with lower monthly payments. And we're actually -- we're seeing some of that now, and that's probably due to the fact that housing prices have increased quite a lot. And for first-time buyers, it's getting more difficult to move into the market unless you go for these options.

[Theodor Fridbertsson, executive]

Could credit risk costs rise above your midterm guidance in 2023? And at what interest rate level do you think that credit demand would start to get chopped off?

[Benedikt Gislason, executive]

This is all the same questions that we had before.

[Olafur Hoskuldsson, executive]

So at the 4.5%, 5% policy rates in Iceland, we still believe there will be healthy credit demand in line with nominal GDP growth. Obviously, the cost of risk guidance is through the cycle. And it depends a little bit where we are in the economic cycle then next year. We're still optimistic for GDP growth next year.

[Erna Sverrisdóttir, executive]

Yes, 3% GDP growth next year. So there's still recovery and robust growth on the horizon.

[Olafur Hoskuldsson, executive]

And I think what is -- what has been kind of going with Iceland in recent months and years is the fact that the -- our business environment has developed quite a lot, and we're seeing new companies growing in sectors, that virtually a few years ago, did not have any export revenues from. This is something that Erna has pointed out many times, the fourth pillar of our economy. And the export -- growth in export value for the fourth pillar sector has outgrown the export growth about 2 or 3x.

[Erna Sverrisdóttir, executive]

Yes. And just our latest forecast, for example, we are expecting then from '22 to 2024, the export revenues from this other export sectors will increase by ISK 100 billion, so that is a lot.

[Theodor Fridbertsson, executive]

And then the final question, I believe, from the online is also from Rahul, maybe ask Erna to answer that. If inflation is peaking at 8%, why do you think a 5% -- why would you think a 5% peak interest rate would be sufficient to cool the economy?

[Erna Sverrisdóttir, executive]

Well, we are looking at that -- the inflation peak would happen in the third and fourth quarter of this year. So with the monetary policy looking ahead, we're seeing that inflation -- given that housing prices would cool off, we're seeing that inflation will come down pretty quickly in 2023. So because of that, the rate should be able to stabilize around 5%.

But there is, of course, the biggest risk is what will happen with wage negotiations this autumn. So if we see very large wage increases and if the government continues to run an accommodative fiscal policy, then this will be a risk to the rate environment.

[Benedikt Gislason, executive]

I think it's -- we always have to put the policy rate levels in Iceland in context with international capital markets. And I think to a greater degree than before because currently, we are a net lender to the rest of the world. We have all the Central Bank cash, quite a large FX reserve unborrowed. And we've seen, in recent months and probably the last couple of years, direct investment into Iceland at levels not seen before.

So the capital flow has to be put into the equation and creating an interest rate differential, which is -- would historically be higher than we've seen before when we were -- when our net international investment position was negative -- greatly negative, could lead to drastic capital flows or dramatic flows of kind of hot capital into Iceland, which then will be another difficult thing to manage with the inflation and the economy. So I'm sure that the Central Bank will have to consider that as well.

[Theodor Fridbertsson, executive]

Thank you. That concludes the questions from the online attendees, and I would like to move to the auditorium. Do we have any questions here? No final questions? All right.

[Benedikt Gislason, executive]

Okay. Thank you all for showing up and logging into the webcast, and we look forward to seeing you in 3 months' time. Thank you.