Arion banki hf

ICEX:ARION

Earnings Call Transcript 2021-Q2

[Benedikt Gislason, Chief Executive Officer]

Good morning all, and welcome to our second quarter and first half investor presentation. It's particularly pleasing to be presenting a strong results across the board, with particular -- particularly strong results in our investment banking operations. This is a third quarter in a row that we meet our financial targets, the ROE targets. And if we put it into a context that we still have ample surplus capital and have not obtained our financial target of 17% CET1 ratio, these ROE numbers are extremely strong.They are, as I said, driven by strong results across the board with Investment Banking performing particularly well. We've seen our core income growing by 10.5% from the same quarter in 2020. And with costs relatively flat from last year, we're seeing an improvement in cost-to-income ratio and obviously, profitability. There are some strong operational milestones in the quarter that I will address later on in my presentation, one of them being the sale of Valitor for $100 million, which is now subject to regulatory approval. And it's fair to say that the seller has consumed or the buyer has consumed a considerable risk because -- and is very engaged and committed to this transaction because if the sale does not complete due to a failure to obtain regulatory approval, the risk of such will be borne by the buyer for the next coming years. And in accordance with IFRS standards, we are not recognizing the profit from the sale until the CPs are all met. Now capital generation has been extremely strong in the last quarters. And despite our efforts to release some of the surplus capital to our shareholders, taking in, obviously, the guidance from the regulator to what extent and the velocity of any capital release, we are still equipped with ample surplus capital, around ISK 42 billion. And we have also to take -- are commencing a share buyback program of ISK 8 billion and have retained earnings, half of our earnings for the first half for dividends for next year. So on top of the ISK 42 billion, we effectively have another ISK 15 billion of capital that we are planning to release to shareholders in the coming months. And when and if the sale of Valitor goes through, another ISK 8.5 billion of distributable capital will be on our balance sheet. And it's been very pleasing to have now received 2 approvals by the regulator for buybacks, which is in itself an acknowledgment of our strong capital position and as well our solid business model. This has all been very well received by the investor community, and it's particularly pleasing to see the growth in the number of shareholders, which grew -- continue to grow in the second quarter, and we have now seen a 30% growth in the number of shareholders this year, and that reflects not stronger interest locally, but also in Sweden because this is evenly distributed between the 2 markets for equity investments. Now we say that the economic rebound has started, but it's interesting to -- or it's important to note that all economic projections were for economic recovery to fully start next year. So as you can see from this slide, we are -- our economists here in Iceland were predicting a slightly kind of mild economic recovery this year than for EU average, 3.3% against the 4.4% recovery for the rest of Europe, and the recovery to effectively take place, a strong recovery, next year. And we say that in our financial accounts for the economic outlook that we provide there. We say that the recent setback with the COVID pandemic is more likely to dampen this economic recovery and probably dampen what was looking like a stronger recovery this year than previously expected than derail this recovery. And that is driven by Iceland's extensive vaccination program, which has weakened the link between infection and hospitalization, and we're already seeing that in Iceland. And this is all contributing to kind of leading indicators showing us that there is recovery taking place. Central Bank has already hiked the interest rates once and is expected to continue on that path. And inflation seems to be on the downward slope as unemployment rate.Now I mentioned some sort of key operational milestones in the quarter. And to begin with, I mentioned the increased interest of private investors to invest into local securities, equities and bonds. And in line with our focus to make financial services more accessible and convenient for our clients, we launched a new feature into our Arion, which is a feature that makes our customers -- makes it more easier for our customers to invest into stocks and bonds in the Icelandic market, and also provides a more comprehensive overview of their investment portfolios. And this has been very well received and comes at a good time. Because as you can see from the activity in the corporate and investment banking, there were a number of IPOs that took place in the second quarter, which contributed to this increased interest for private investors. And I would like to mention 2 IPOs were Arion was leading with the services on the First North listings of Play -- Fly Play and Solid Clouds. And it's really good to see the -- how receptive investors are to new listings and the new kind of funding opportunity that is available for companies that are kind of early stage in their life cycle. On top of that, we managed a fairly large bond offering by Alvotech along with Morgan Stanley. We also managed the first senior unsecured bond issued by a corporate in the local market in more than 10 years by assisting Iceland Seafood to fund itself in the bond market. And finally, we managed the sales process of Lyfjaval and AGR Dynamics. And all of these transactions contributed to the strong quarter for Investment Banking.Now kind of the final milestone, which was quite a big one because this is a project that we've been working on for more than 2 years now, was to go live with SOPRA. The SOPRA core system, which is kind of a payments and deposit system, a new system that will enable us to do some cost savings on the IT side and also enhance our services. For Valitor, I would like to say that this has been an asset held for sale for quite some time. We think that this transaction is very beneficial transaction for both parties, and it's very good to see a company like Rapyd, showing an interest in Valitor. They are extremely kind of -- they're at the forefront of the fintech industry in Europe and are very committed to building Valitor as a kind of a European player as seen from statements made by Rapyd post the transaction.Now another operating milestone is that we've effectively commenced an integration process of Vordur with the insurance company with Arion, and this is driven by a strong trend in the industry where bancassurance is now the fastest-growing element of insurance in Europe. And this is very much driven by the fact that there's increased convenience for clients to have their services at one place. This has evolved in such a direction because of new digital services, which make the customer journey experience more seamless than before, but also because we're seeing the branch network changing or conforming from kind of the typical service -- cashier services into value-added services, where clients come in and get value-added services for their financial needs on a comprehensive basis.For us and Vordur, this offers synergies, obviously, cost synergies, but also cross-selling opportunities and the ability to enhance client bases at both companies. Vordur will remain an independent company, as it is required legally, but is going to move into our headquarters, and we're going to mix the cultures of the 2 companies. Now another milestone that we recently completed at the beginning of July was that we issued our first Green Bond under a Green Financing Framework. That effectively is a milestone of more than a 5-year journey that we've been on, where we sort of gradually and prudently been working on our sustainability journey, starting by becoming signatory to a number of sort of sustainability efforts, both locally and internationally.And then focusing on our products, rolling out a couple of green products before setting up this Green Financing Framework and issuing our first Green Bond onto that. This is the -- it's the main kind of eligible assets currently in our portfolio that we use for financing are the green buildings and sustainable fishery and aquaculture. But as you can see from this slide, there are a number of other kind of credit portfolios that offer opportunity to -- or are eligible to be financed through a Green Bond issuance. And for us, that is a kind of -- it's a good tool to have a well-structured framework around what kind of assets are eligible under this Green Bond framework. This ESG format provided a clearly visible added value, as we saw are in fact most favorable funding rates of bonds issued under the bank's EMTN program. So far, we issued this bond at mid-swap plus 80 basis points, which is considerably below what we've been issuing in the senior unsecured market so far. And then sort of concluding on my presentation before I hand over to Stefan Petursson, the CFO, who will go through some of the numbers in the second quarter, I just want to highlight that we are continuing to build on the positive operational progress that we've demonstrated in the last few quarters. And with the improving economy, this offers a number of opportunities for the bank. And we're going to seek market share and target certain segments that we think are beneficial to our business model. Bancassurance obviously being one of those, and we see great opportunities there with bancassurance ratio for Vordur being relatively low compared to kind of other efforts in Europe. So there's a great opportunity to increase market share at Vordur and improve services across the board towards our clients. We're well ESG funded both through green deposits and now through the Green Bond issuance. And this opens up to opportunities for further advancements in that field. And I think our focus for the next couple of years will be then on the asset side, making real meaning in sort of availing funds to projects that really contribute to the sustainability of our economy.I've spoken about the ample, I would say, gross -- our grossly overcapitalized position. And we're obviously committed to releasing that capital and have today commenced a share buyback program. And we'll continue to release capital to shareholders, while we have that position, and it's a kind of a positive problem to have. That our capital generation in every quarter now has become so strong that we -- we're still not kind of making progress on this ample capital, but I'm sure that we will see an acceleration into the autumn and winter for the capital release. And that includes, obviously, the ISK 8 billion buyback, our commitment to paying out 50% of profits, and then releasing some of the surplus capital that is currently in the business and will become availably distributable once we sell Valitor.And with that, I'm going to hand over to Stefan Petursson.

[Stefan Petursson, Chief Financial Officer]

Thank you, Benedikt. Good morning, everybody. It's a pleasure to be here with you to tell you a bit about our performance in Q2. This was -- as Benedikt said, this was a very good quarter -- outstanding quarter in a way, where sort of every line item fell for us. I mean core revenues were up, other items were favorable. Costs were under control. And as Benedikt said, we have ample surplus capital. And if we look at our medium-term targets that we met all, then we see that return on equity was 16.3% in the quarter, it is 14.3% during the first half of the year. ROE, assuming our target CET1 ratio was actually over 20% or over 21% in the quarter and close to 19% during the first half, operating income over REAs 8% during the quarter and 7.5% during the first half, again, exceeding our target of 6.7%. And finally, the cost/income ratio is sort of hovering around between 42% to 44% during the first 2 quarters. So the only target where we are in a way missing is our surplus capital, as we have said, both now and in our previous meetings. And obviously, that is something that we continue to work on.If we look at the income statement, then as we can see, net earnings amounted to ISK 7.8 billion during the quarter, up 59% year-on-year and actually from ISK 6 billion in the first quarter. The core income items were favorable, up 10.5%. And when I say core income items, I'm talking about net interest income, net commission income and net insurance income. But on top of that, net financial income was positive by ISK 2.2 billion, slightly down actually from last year. But as we remember, in Q2 of last year, markets were rebounding after the COVID situation of Q1. So that is quite understandable. So operating income is up 7% year-on-year. Operating expenses are flat, meaning that operating profits of ISK 8.6 billion are up 13% year-on-year. The bank levy, as we know, it is in line with budget, but net impairments are positive during this quarter and actually were positive in the first quarter as well. And what is happening here is basically that mortgages are becoming a bigger part of our loan book, which is positive.And then secondly, our IFRS models are slightly less pessimistic than they have been over the last -- over the recent past. This means that earnings before income tax is ISK 9 billion, up 41% year-on-year. Our income tax rate is low. It's only 15.5%, attributing to our revenue composition. So net earnings from continuing operations are ISK 7.7 billion, up 55% year-on-year. And then we have a small revenues from -- small income from discontinued operations or held for sale assets. But as Benedikt said, the sale of Valitor, which would go into this line, will not be accounted for until regulatory approvals and all CPs have been met. And obviously, we would hope for that to happen before the end of this year. Again, meaning that net earnings are ISK 7.8 billion, up 59% year-on-year.Just a few words about the net interest income, up 2% from the same period last year, but we are very pleased to see our NIM rebound to 2.9% in -- again, in a difficult interest rate environment and having the surplus liquidity that we have. But it's fair to say that, that we are quite, in a way, the recent change in the stance from the Central Bank is positive for the bank. We saw the 25 bps rate hike in May. We were able to work with that a little bit. Clearly, the situation has been for us that a lot of our deposit base has been around 0, meaning that the interest -- that the deposit margin has been very low. With sort of continued rate hikes at the Central Bank, we can manage our NIMs better. So again, a positive development for the bank. Net interest income over average credit risk continues at strong levels. And if we look at the slide chart on the bottom part of the graph, sort of the bridge from last year, then we can see that, obviously, in a lower interest rate environment, we are receiving lower income from credit institutions. Our loans from customers are yielding lower, but that is offset by our performance on the security side by sort of cost reduction on the deposit side and the borrowing side, meaning that we have been managing our affairs pretty well. But finally, we are seeing a reduced income from the inflation from last year. That is not because inflation is low because inflation has been quite high over the last quarters. The thing is that we have seen a shift in the market from inflation-linked loans over to fixed or floating rates -- floating rate nominal loans. And this is a shift in the market, meaning that our inflation in balance has vastly reduced.We have talked about fee and commission income. We have had very strong growth in that over the last quarters. The corporate activity has been outstanding. CIB has been very busy on all kinds of transactions. And we see this merger as -- and as we have discussed in the past, this merger of Corporate Banking and Investment Banking, we see that as a very positive sort of move on our behalf. Asset Management is doing well as well. And in a way, the only commission business that is still sort of -- that still can be improved is sort of retail banking, where we are confident that the economic -- increased economic activity will feed into increased commission income going forward. On the insurance business side, the Vordur is doing extremely well with a combined ratio of 91.5%, which is very competitive in the domestic market.On the OpEx side, as I said, our cost/income ratio has been sort of around or below 45% over the last few quarters. We continue sort of decreasing the number of employees, which are down 7% at the parent company, 5% at the group year-on-year. Salary costs are relatively stable, though. We do have wage inflation in Iceland. And we've seen a certain shift of the staff composition as well. Other OpEx is stable as well. But noticeable changes in the composition, thereof, we are seeing a reduction in IT costs, very much according to plan. We're also seeing good progress on the housing cost side, but depreciation is slightly higher than it was in the past, again, mainly a function of the SOPRA core system.The balance sheet, simple, strong, almost 70% of assets are loans to customers. It grew by some close to 4% from year-end. The liquidity position is very strong. The LCR ratio was 215%. Our ISK liquidity ratio is 195%, meaning that we are well positioned both to work with our customers as well as to distribute capital over the coming months. There has been a noticeable change on our lending side over the last few quarters, where we've seen retail mortgages increase, relatively strongly, up almost 25% year-on-year. We have also seen a decrease in the corporate book. And I would like to reiterate that is not because -- I would like to iterate that, that is not because there is not activity on the CIB side. We are seeing that activity in the -- on the commission income side, where our strategy of capital velocity is actually to maximize the yield on the risk weights that we are putting in on the corporate side. So we are generating a lot of activity. It doesn't all end up on our books. We sell that syndicator and so forth. I also mentioned the indexation imbalance. And on the bottom right-hand side, we are seeing this development, 36% loans to customers were CPI linked a year ago is down to 27% now. And this is a trend that continues. We feel we are adequately impaired given our situation with COVID even the Delta variant. The book value of COVID-19 impact loans is ISK 91 billion, 10% -- 6% of the loan book, of which ISK 77 billion are secured with real estate. And the tourist-related loans in the book, they are valued at ISK 74 billion. So an exposure that we feel is fully manageable.On the liability side, again, very strong ratios, CET1 ratio of 22.7%, capital ratio of 27.2% and a leverage ratio of 14.6%. The very positive development that we continue to see is the increase in deposits, 8.7% from the same time last year. We have been relatively quiet on the wholesale funding side, both domestically because we have been very well funded and also internationally. And the recent change to that is the Green Bond that we issued the other day and Benedikt mentioned. We have also been busy distributing capital, paying a dividend of ISK 2.9 billion and buying back own shares of ISK 14.9 billion during the first half of the year. Regardless of that capital distribution, our capital ratios are very, very strong. As I said, 27.2% of capital, 22.7% of CET1, somewhat enhanced by changes that were made to -- with CRR II, the SME supporting factor, counterparty credit risk and also sort of treatment of software assets.But what this really means is that we do have surplus capital of ISK 42 billion now. In addition to that, we have the foreseeable buybacks and the profits for the first half of the year, amounting to some ISK 14.9 billion. And on top of that, we will have capital release when Valitor is sold or the sale of Valitor is finalized, meaning that we have ample capital to distribute. And the challenge is to do that in a way faster than we are generating capital. So again, a positive problem and something that we will be working on diligently over the coming months.So having said that, I will hand it over to the moderator for questions. Again, middle of the summer, the weather is good. I'm not necessarily expecting a lot of questions, but we'll see. Thank you.

[Operator]

[Operator Instructions] There are no questions at this time. So I'll hand back over to speakers.

[Benedikt Gislason, Chief Executive Officer]

And there are -- since there are very few here in the auditorium, I expect no questions from here. I think we just end the session, fully understand, people are on vacation and sun is shining. Wish you good rest of summer vacation, and see you next time.

[Stefan Petursson, Chief Financial Officer]

Thank you.