Arion banki hf

ICEX:ARION

Earnings Call Transcript 2020-Q2

[Benedikt Gislason, Chief Executive Officer]

Hello, I would like to welcome you to the webcast presentation of Arion's second quarter results, which I'm really pleased to present, along with my colleague, Stefan Petursson, today.First of all, we delivered strong results in the second quarter with a return on equity of some 10.5%, core -- our core revenues increasing by 1.8%, and at the same time, operating expenses down 3% year-on-year. This represents a focus on our sort of core revenues and operating expenses over the last 12 months, but also represents that we are continuing this focus. We are seeing -- we will be aiming for further cost reduction initiatives, rebalancing of the loan portfolio and repricing will continue.And for example, in the second quarter, we saw a rebalance -- rebalancing between corporate loans and the mortgages, where we saw a similar increase in mortgage lending as our corporate book, primarily single -- large single-line exposures reduced by. And we will continue to focus our operations on capital discipline and increasing capital velocity with the emphasis on generating more revenue from the capital that we deploy in our business.We are operating, obviously, in a challenging environment, where the gross domestic production is expected to contract here in Iceland, and unemployment has been on the rise, despite fairly strong economic stimulus and support measures taken by both the treasury and the Central Bank. But in these challenging environments, we remain committed to supporting our clients through these economic downturn. And we are actually quite uniquely positioned to do so.First half of the year was unusual in a sense because we saw our own funds increase by some ISK 28 billion or 16%. That is primarily due to the issuance of additional Tier 1 capital note and retraction of proposed dividend. That means that more than 1/3 of our Common Equity Tier 1 capital is now in excess of regulatory requirements and doesn't need mentioning. It leaves us in an extremely strong position to deal with the crisis -- economic crisis here and support our clients.It's fair to state that Iceland has coped very efficiently with the COVID-19 pandemic. And the country has been open for tourism since June 16, with some 53,000, 54,000 travelers being tested at the borders. And this is of great importance for the economy, obviously. And the reopening of the Icelandic economy has progressed well and at a rapid pace, and all leading indicators are showing a market upward trend.Coming to the responses to the COVID-19 in Iceland. They have been a good success. And the resurgence of coronavirus cases in the last few days is going to be dealt with in the same manner as before, mass testing, highly efficient contact tracing and self-isolation measures, along with social distancing measures. So we're optimistic that we will continue to, not only flatten the curve but almost eliminate it.If you look at the Treasury's response and Central Bank's responses in the last quarter -- in the second quarter, we saw 2 new measures being introduced. The support -- business support loans, which we are very pleased to sort of facilitate through our clients, and we actually invested into the process of doing so and created a fully automated process, which means that it's proven straightforward to process those loans to our customers.Now the second quarter, in particular, was quite a learning curve for everybody, I guess. And in the case of Arion, we were able to operate fully and service our customers with our branches closed during the lockdown and 85% of our staff working from home. And this experience will expedite, obviously, further developments in the bank's operations.Now coming to the macroeconomic environment before I hand over for Stefan to cover the financials. There's a few slides here. Obviously, this has proven very sort of challenging for Iceland, reliant on tourism to deal with the COVID pandemic, and this has heavily impacted our economy. But what has been good to see is that travel restrictions, they worked in both ways, and Icelanders have not been traveling much abroad. And the local tourism has been flourishing this summer. And the local economy has been strong. So that is mitigating the sort of massive contract drop in tourist arrivals. But it remains to be seen. Obviously, there is a high degree of uncertainty how this thing progresses into the autumn.If we look at the, I mentioned the local economy, it's a bit of tale of 2 worlds. As I mentioned, the local economy has been quite strong, and that has been driven by real wages moving higher in the last couple of months. So the purchasing power of the local consumer is increasing. And inflation, despite sort of depreciation to krona, the inflation rate has remained quite low compared to sort of previous economic downturns in Iceland. And the card turnover and other leading indicators demonstrate that we are on an improvement road when it comes to our local economy.The final slide here is on the fiscal and monetary responses. You can see that the pandemic responses, where the balance sheet of the Treasury was used, is comparable to the rest of the Nordics. Actually, we rank second in terms of measures as part -- as a ratio of GDP, 4.2%. And it's fair to state that the Treasury is in an extremely good position to continue to use its balance sheet to support the economy. And up until now, measures have been primarily focused at corporates, but there are clearly tax measures that could be taken towards households, if needed.That concludes my part of the presentation, and I hand over to Stefan.

[Stefan Petursson, Chief Financial Officer]

Thank you, Benedikt, and good morning, all. Now we had a very good second quarter 2020. And what we are primarily pleased to report is that the core trends are improving. We saw an improvement in the net interest margin in a difficult environment. Net interest income over credit risk is improving. Core revenues are up almost 1.8%. OpEx is down. So the core items are moving in the right direction. But we should also note that the results there are obviously enhanced by very strong net financial income, which helps.The balance sheet and loan book, they increased, but REA remained stable. So we now are focused on capital. Our funding mix is improving with deposits trending higher. And as Benedikt says, we have ample surplus capital. So if we, like, take a look at our financial targets, we met or beat all of them in the second quarter. But looking at the first half of the year, after a very difficult first quarter, we are still lagging somewhat behind, and we need to do better.Looking at the income statement. Then, obviously, our net earnings improved substantially or by over 130% from the same quarter of last year. All core income items are moving in the right direction with the exception of net insurance income, which is slightly down based solely on the fact that Vördur, our insurance subsidiary, offered a discount on fees, sort of COVID-related discount, during the second quarter. But that is on -- that will -- that is off now, and we have high ambition from -- for Vördur going into the year.Obviously, net financial income is very high. So operating income is up some 15% from the same quarter last year. Costs are moving down, both -- salaries are down some 6% from the same quarter last year. Costs are stable, but we aim to bring them down, and I'll talk about that in a sec. So clearly, the operations are improving.Bank levy is down. The government, as a COVID-related measure, decreased the bank levy from 37.6 basis points to 14.5 basis points, a very welcomed move, even if we say that this is still one of the highest bank levy in the world. And our net impairments during the quarter are 13 basis points, which we are adding to the 38 basis points that we impaired in the first quarter, and I'll talk about that later as well.So earnings before taxes are up some 74% at ISK 5.4 billion (sic) [ ISK 6.4 billion ]. Net earnings from continued -- or continuing operations are also up 76% at ISK 4.9 billion. Our discontinued operations, which have been hurting us quite substantially over the last few quarters, they are sort of at a balance in this quarter. We expect some volatility in this line item going forward, but at a vastly reduced levels from what we've seen over the last few quarters. So our net earnings again are ISK 4.9 billion, up 134% from the same quarter in 2019.The half-year figures, I'm not going to dwell on too much because they are categorized by, firstly, volatility in the net financial income and very high impairments, ISK 3.7 billion or ISK 3.8 billion in the first half of the year, 51 basis points, as I've said. But I think the thing to note there is that we are seeing substantial improvement in core income, increasing by some 5.3%. And we are seeing good trends in operating expenses as well, down 7%. So -- then, looking at the core of the bank, it is doing better.Just a few words about net interest income during the period -- during the quarter. Obviously, we are very pleased to be able to report 2.9% net interest margin at a time when we are the lowest or in the lowest interest rate environment, I think, we have ever seen here in Iceland.At the same time, as we have issued relatively expensive subordinated debt, an AT1 debt, sort of teeing up for a capital release and at a time when we have, in a way, excess liquidity due to the fact that the Central Bank asked us to withhold dividend payments due to the COVID-19 pandemic. So 2.9% is actually very good, up 10 basis points from last year.Also, as Benedikt said, sort of our focus on capital, we are seeing a substantial improvement in net interest income on credit risk. Something we will continue to focus on. And the bridge basically shows what is happening. I mean we are seeing sort of given the reduction in rates, we are actually getting less revenues both from our deposits at -- with all financial institutions, and actually, from our customers who are paying us less. But that is more than offset by our cost savings from both deposits and wholesale funding.There is a lot of volatility in the cost income ratio, where we do have a target of 50%. This is obviously characterized by the net financial income, massively negative in Q1, positive in Q2. But our cost income is close to -- is 54.7% in the first half of the year. It is still too high. We want to bring that down to 50%. There are, however, very positive signs.We are continuing to reduce the number of staff, that is down by some 14% from the same time last year. And expenses are under control. They are stable. We are seeing some change in the mix. IT has been very costly over the course of this year. Part of that is obviously COVID-related because we had to gear up the staff so that everybody could work from home. But we will focus on our IT expenses over the coming quarters. And obviously, we will just focus on costs as every other bank is doing.Going over to the assets side. As Benedikt said, the balance sheet is extraordinarily strong. It is very prudent. It is comfortable at this -- sort of given where we are now. It is not, in a way, efficient in the long term. And it goes without saying that we want to resume our capital release when the time is right. It is still very simple, 66% of the asset side, there's actually loans to customers, well diversified between individuals and corporates. And then just a very large liquidity buffer, and we see that we have LCR of over 200%. And LCR and ISK, which has often been critical, is over 150%. So we are in a very solid position to basically do whatever, and mainly, to work with and support our customers in their challenging times.The loan book is relatively stable, but we do see sort of a change in the mix. We are seeing our corporate -- large corporate loans trending down. That is very much in line with our strategy to sort of increase our capital velocity. The mortgage lending has been doing very well. And we've been able to sort of have our REAs stable throughout.Just a few words on the impairments. As I've said before, we impaired 30 basis points -- 13 basis points in the second quarter, taking us up to 51 during the first half of the year, which we believe is very prudent. Now in the second quarter, this was mainly due to sort of modeling exercises, the IFRS 9 models, where we increased the unemployment rates in our models and took that into account. And that accounts for almost 7 basis points of the 13. Obviously, we do have single name or specific impairment, stage 3, that's 3 basis points, and then 3.6 basis points in other impairments.And you may remember that when we met here after the first quarter that -- we got the question, shall -- should we, at that time, multiply that by 4 to get the impairments for the year? And the same question now would be, should we double this to have the impairment for the year? And the answer to that is no. I mean this is our best estimate of our impairment need at this point in time, given the visibility that we have now. Granted, the visibility could be better, to be honest, because there is still a lot of uncertainty in the economy. But sort of any calculation or doubling of this impairment to estimate the full year would be incorrect or would not be accurate in our minds.We are very well collateralized. We feel our loss allowance is actually quite high. Our biggest sort of sector are loans to individuals or mortgages. And having 14 basis points in allowance on all that is actually very high. Other individual loans, including car loans that we have high impairments. And sort of across the board, we have -- sorry, high allowances. And across the board, we have solid allowances in our opinion. Just to note, other corporates, where it looks as if our collateral position is quite weak, this is a space where we have many of the largest companies in Iceland, listed companies. And we actually feel that we are actually very sort of -- our protection on that front is very good.Looking at the liabilities side. Our equity position is very strong. The bank is -- like I've said, the bank is well funded. We have been increasing deposits in our funding mix. And -- but the bank has a good blend of deposits, senior bonds in the international markets and covered bonds in the domestic market.Own funds are obviously very strong. Our capital ratio is 28.1%, and our CET1 ratio is 22.9%. The target is 17%. Our plan was to bring that down to 17%, but it has been increasing. So obviously, this will reverse at some time. We would like this to reverse sooner rather than later, obviously, but we will work with the Central Bank on that.Another measure of financial strength is the leverage ratio, where we are now close to 15%, which is extraordinarily strong in every context. So again, we had teed up for capital release. That's been postponed, but it's still on -- it's still very much on the agenda.So where are we now, looking forward? We believe that the macroeconomic developments, both in Iceland, and probably, more so internationally, we will dominate in the economy here and our businesses over the coming quarters. We are a part of the global economy. Obviously, we will support our customers. And we do have the financial strength, as I've said, to do so.We will continue to focus on our core business, core revenues, and obviously, operating expenses. As I've said, there is still a lot of testing here, a lot of uncertainty, and further impairments can -- should be expected. We just don't know the amount. We say, and we have maintained that the situation can open up possibilities, but we will be very careful about our capital. We won't deploy it unless it is prudent to do so. And we are committed to our medium-term targets, and as we say, assuming that the economy recovers in the medium term. And quite frankly, we are very pleased to meet those targets in the second quarter in a very difficult economic environment.So it is over to questions. Benedikt?

[Benedikt Gislason, Chief Executive Officer]

Yes, thank you, Stefan. And like before, we now open up for questions. And we'll usually open it up for questions through the phone before opening up the questions from the auditorium. I think it's safe to state that due to the peak of the summer holiday, there are not many here today, but I'm sure that we'll get some good questions anyway. So we open up for questions.

[Operator]

[Operator Instructions] Our first question comes from Markus Pops, Goldman.

[Markus Pops, Former Associate]

I have a few questions. So should I, actually, read them out all at once? Or should we go one by one?

[Benedikt Gislason, Chief Executive Officer]

Yes, just all at once. We'll take the notes.

[Markus Pops, Former Associate]

Okay. So first, on loan losses. Just wanted to confirm that I read your comment right in terms of you, basically, saying or guiding that we shouldn't extrapolate the first half losses for the full year, i.e., meaning that we should see some sort of normalization in loan losses in the second half of the year. And maybe related to that, if you could just maybe give some color on the bankruptcies that you're seeing in Iceland right now, especially in the tourism sector but other sectors as well. So sort of what are the key drivers there going forward?Then secondly on costs, just wanted to ask, obviously, you've done a good job in terms of bringing the FTEs down, which I think is 15% year-on-year. And that's a pretty material figure. So my question was just how much more do you think you have left to do there on the cost side in terms of your workforce? Or is it more sort of just letting those benefits feed through the P&L now?And lastly, just on capital. As you said again, that over 1/3 of the Arion capital is in excess of the requirements that you have. But at the same time, I believe that you didn't accrue anything for dividends on 2020 profit so far. So I'm just wondering, should we sort of read anything into that in terms of you also not planning to pay any dividends on your 2020 earnings on top of sort of canceling your 2019? Or if you could just sort of clarify, giving me more color on the discussion with the local regulator around any potential dividend distribution from here onwards?

[Benedikt Gislason, Chief Executive Officer]

Thank you so much. Really good questions. When -- sort of we realized that some of the things that we present is maybe not comparable to how, for example, Nordic banks present the figures. And one thing is the loss allowance or the provisions where we've just calculated those -- presented those on a sort of quarterly basis as a ratio of the loan book and not multiplying by 4 or 2 to give a -- sort of a figure for the full year.And I think our approach here has been that this is -- sort of we take the best estimate with a forward-looking guidance, and that's why sort of the 51 basis point, which actually you can calculate to be 56, if you adjust for massive sort of refinancing repayments in the mortgage space and the rebalancing of the corporate book, putting sort of revisions back to the -- to this provisioning line. So if you test for that, our provisioning is more like 56 basis points, which on an annualized basis is 112. And that compares with the major Nordic banks favorably, I guess, or in a similar manner.And like Stefan said, we provided answer to -- in the first quarter that those provisions would not represent sort of the -- we should not be taking linearly throughout the year. And I think the second quarter provision demonstrates that. They are lower, much lower.And then coming into sort of the corporate space here and bankruptcies and things like that, there is a new provision in the law, which effectively enables a -- sort of a managed sort of a bankruptcy protection scheme similar to Chapter 11.

[Stefan Petursson, Chief Financial Officer]

Chapter 11, exactly.

[Benedikt Gislason, Chief Executive Officer]

And that is now being taken up by a number of companies, especially operating in the tourist space. And we -- what we are hoping is obviously that this gives the owners the opportunity to discuss capital raising, consolidation and things like that, which should sort of develop these companies into stronger units with more sound sort of operations going forward.I think even though we have a high collateralization on our book, and mostly, in real estate, I think all banks will want to shy away from having to become owners of companies and operate them, especially maybe in sort of client-facing situations. So we have not seen as of yet because of this new provision in law any major bankruptcies. The biggest restructuring that is taking place and is going to be a key sort of a restructuring for the future of tourism and Iceland is the Iceland debt restructuring. And according to the latest news, we should be expecting some release of prospectus and a capital raising as soon as next week. So it remains to be seen.The -- on the capital and provisions, it's right, that's another different kind of approach to some of the Nordic banks. We have not been provisioning or sort of taking aside a portion of our P&L for future dividend distributions, and actually categorized a planned dividend back into capital in the first quarter or after the COVID pandemic hit, but this does not reflect our willingness or eagerness to release surplus capital. It's just -- it brings the whole capital into one bucket.And in our view, I mean, we have the ability to post -- to share buybacks and dividends once the sort of the environment allows for it, and we see the -- see signs of economic recovery. And obviously, we listened to the guidance from the regulator on this front. But at the same time, we're in a position where we probably want to be the best capitalist banks in Europe at the moment and even on a wider scale and would want to see some kind of sort of proportional measurement on sort of when banks can sort of allow to release surplus capital without impairing their operational ability going forward.

[Stefan Petursson, Chief Financial Officer]

And we are facing the same here in Iceland as we hear from Europe as well. I mean banks are differently -- I mean, banks have different capital levels. But the regulatory stance now is basically one size fits all, and that must change over time.

[Benedikt Gislason, Chief Executive Officer]

Your final question on costs and how -- what can more be done there? And it's right our measures that we took last autumn, they were sort of -- they were general sort of FTE reduction across all units. And obviously, sort of doing that again is unlikely to happen. But what we are focusing now is efficiency, simplifying our processes and products and sort of gradually streamline the business, and this is a challenging job, and we have a lot of focus on it at the moment. And the reason why we're mentioning it here today is that we feel confident that we will achieve further cost reductions well into next year on the back of these sort of exercise of this work.

[Stefan Petursson, Chief Financial Officer]

Yes. And just to add to that, I mean, we had a very good exercise during COVID. I mean we had 85% of the bank working from home. We were able to serve all customers with, I think, pretty much all their requirements and needs. And I think this experience will only sort of expedite the operational changes that we are looking into.

[Benedikt Gislason, Chief Executive Officer]

And we've already made some changes to the branch network, for example, reduced opening hours. And the branches now serve more as a meeting place, financial advice rather than sort of simple sort of services.

[Stefan Petursson, Chief Financial Officer]

Yes.

[Benedikt Gislason, Chief Executive Officer]

Yes, which we're pleased to see the uptick in the use of the digital channels. And the sort of older age group that maybe hadn't, before the lockdown, had a look at these services and familiarized themselves with it are now frequent users of it. This is very pleasing.

[Markus Pops, Former Associate]

Okay. Yes. Can I just have one quick follow-up on coming back to the CapEx point. If you wish to pay anything on 2019 dividends or -- 2019 dividends, do you require the regulator's approval at this point? Or is it more that you're just following the guidelines, but there is no sort of hard approval required?

[Stefan Petursson, Chief Financial Officer]

So in essence, if we want to pay, be it the regular dividends or extraordinary dividends, then we do not require a special, let's call it, a permission or approval from the regulators. But I think it's fair to say that we, as a bank, we want to work with the regulators. I think the Board is there as well. And as long as regulators are sort of -- are prudent and makes sense, then we will follow those guidelines.

[Benedikt Gislason, Chief Executive Officer]

But for buybacks, we would need -- yes, to add to that, on buybacks, we would need the regulatory approval and a sign-off. And that's just how the legal environment -- governed by the legal environment.

[Operator]

There appears to be no further questions. So I hand back to the speakers for any other remarks.

[Stefan Petursson, Chief Financial Officer]

Sorry, can you repeat this?

[Operator]

There appears to be no questions. So I will hand back to the speakers for any other remarks.

[Benedikt Gislason, Chief Executive Officer]

Okay. Yes. So then, I guess we open up to questions from the auditorium, if there are any? We haven't had many so far in our webcast presentations.And on that note, we thank you all for dialing in or showing up at our headquarters, and look forward to seeing you in 3 months' time, again. Thank you all.

[Stefan Petursson, Chief Financial Officer]

Thank you.

[Theodor Fridbertsson, Head of Investor Relations]

Thank you.