Arion banki hf

ICEX:ARION

Earnings Call Transcript 2021-Q3

[Benedikt Gislason, Chief Executive Officer]

Good morning all, and welcome to our third quarter results -- presentation of our third quarter results. It's very pleasing to present these results for the third quarter as this is one of our best quarters in recent years with a 17% ROE for the quarter. And if you look at it on a normalized basis with our set 17% target capital ratio, the ROE is actually higher or 21.8%.We continue to show growth -- strong growth in core income in the quarter, 7.5% now in the third quarter, and that is underpinned by a strong performance on the fee income side, which is the best fee income that we've had since 2016 of ISK 3.8 billion. And that is contributed by most fee income lines. There's only the Card and Payment Solutions that is flat year-on-year. But for example, in Asset Management and Corporate Finance and Capital Markets, we are seeing fees more than 60% higher than last year.A substantial loan growth in the quarter, and we say that it reflects the economic recovery in Iceland, and we saw our loan book grow by ISK 53 billion in the quarter or 6.3%. And what is different from previous quarters is that this loan growth is now hand-in-hand between corporates and individuals. The capital ratio of the bank continues to be quite strong. And despite a ISK 26 billion capital release already done this year, and we will end the year with at least ISK 36 billion, we're still grossly overcapitalized with more than ISK 50 billion of capital if you include the buyback program that we are now launching and the retained earnings for dividends of next year. And if you add the ISK 11 billion that we expect to receive from the sale of Valitor, which is subject to regulatory approval, it's clear to us that we need to revisit our capital release plans if we stand to obtain the 17% CET1 target, and that might involve further capital release and changes to our financial targets.Now if we look briefly at the economy, you can see that most economic indicators are strongly demonstrating a sharp recovery in the economy, like it's reflected in the loan growth. And unemployment rate has come down considerably since it peaked in -- during COVID times. And this is also demonstrated by the fact that Central Bank has already raised interest rates or policy rates 3 times this year. And if you look at kind of -- if you do a kind of outlook review, the tons of trade are very favorable for Iceland. The outlook for our main export industries are good and recent announcements of, for example, the [indiscernible] quota for next year are very promising. So the outlook for the Iceland economy is good at this point in time.Now in this quarter, we did some changes to our organizational structure and also announced a further kind of integration of our subsidiary, Vördur, with our operations. And we say here that we have now created a customer-centric organization by the introduction of a new division, Customer Experience, which was created during the quarter, and we added a new Managing Director to the Executive Committee. This division is designed to enhance our comprehensive sales and services channels with a special focus on digital services and plays a crucial role in developing the partnership between Arion and Vördur, creating integrated financial services, which can be accessed through diverse and modern service channels. And we identified substantial bancassurance opportunities, which form a sort of key pillar of our strategy for the coming years.In this quarter, we made a substantial effort on the funding side with an inaugural euro covered bond issuance. This is the first euro-denominated covered bond issuances of an Icelandic bank and marks a new way for us to finance our mortgage portfolio. I think it's worth mentioning that Nordic banks tend to fund a relatively high portion of their mortgages through these means. There are banks -- comparable banks that fund up to 60% of the mortgages in the Eurobond -- covered bond market. And we think this will be a new norm for funding mortgages in Iceland, but obviously reliant on the functioning of the FX market. And what was particularly pleasing, obviously, with this bond issuance was that our funding spreads were extremely favorable compared to where we've been funding previously and actually the best funding spread at an Icelandic entity, including the Ministry of Finance or Treasury of Iceland, has achieved in international markets over the last 13 years.In the quarter, we released an updated quality and human rights policy with clear objectives, well-defined KPIs. And what we're particularly proud of is the initiative that the Board approved earlier this year to support, where we are effectively topping up the parental leave fund payments to make sure that our employees, irrespective of their monthly salary, will stand to receive 80% of their salary for the duration of 6 months during parental leave. And what we witnessed here is that men generally exercise the rights to parental leave less than women, and the aim here is obviously to increase the number of men exercising their right. And then we hope that in the long term, it will contribute to pay equality and gender quality at management level and in other areas of the bank.And finally, before I hand over to my colleague, Olafur Hoskuldsson, the CFO, I want to remind you of our Capital Markets Day. It's our second Capital Markets Day since we listed, which will be held on November 17 here in our headquarters, webcasted live, and will be sort of held during the morning session starting at 9 a.m., and we plan to finish before noon. And I remind you, if you're interested in joining, to sign up online.And with that, I'm going to hand over to my colleague, Olafur Hoskuldsson.

[Olafur Hrafn Hoskuldsson, Chief Financial Officer]

So first of all, thank you, Benedikt. And of course, a great pleasure to present my first results as CFO of the bank, and I'll hopefully see most of you in person on the Capital Markets Day in November. Especially so, of course, presenting another very robust quarter for the bank. And we're seeing, as Benedikt mentioned, our core operations trending very positively and the outlook being again, positive. We're meeting all our operational targets and other items as well this quarter were favorable with financial income and reversal of impairments positive, reflective of the positive economic outlook. Return on equity, again, 17% for the quarter, 15.2% for the 9 months. And as Benedikt mentioned, assuming our 17% common equity target, that resulted in 21.8% for the quarter and 19.5% for the year. Capital position, again, remains very strong, although it's very pleasing to see that we're making milestones in the optimization efforts and especially so in this quarter, of course, being driven by our buyback program successfully executed this year.So just moving to the income statement. Net earnings for the quarter, ISK 8.2 billion, ISK 22.1 billion for the 9 months 2021. As Benedikt mentioned, core income, healthy growth there, 7.5%, which is a clear positive. I will go into more of the core items in the following pages. But as I mentioned earlier, there were a few sort of more irregular items that were positive this quarter. So I'll highlight those here. It's effectively twofold. Firstly, of course, given the economic outlook being more -- becoming more positive, we're reversing some of the impairments, so that's a ISK 718 million number in the net impairments line. Secondly, we are making some milestones in sale of noncore assets that's been on the books for a while for the bank. You can see those milestones being reflected in the other operating income, which is a development plot held by our subsidiary, [indiscernible], and -- as well as a discontinued operation line, which reflects a milestone in the sale of one of our travel agencies within Sólbjarg subsidiary. So just moving to the more core items. In terms of net interest income, the NIM slightly -- dropped slightly this quarter, 2.7% from 2.9% last quarter. We see this as defensively strong. We're operating in a very low interest rate environment still. We did some -- this quarter, we had 2 funding issues in euros, so we were prefunding upcoming maturities. So we're effectively overly funded this quarter. We're also seeing over the past year, of course, a significant shift in our loan book with mortgages becoming a bigger part of our total loan book as well as within the mortgage pool, CPI-linked mortgages becoming much less. And you can -- that's reflected in the net interest income bridge where, of course, the inflation effect versus last year is the big difference.I think with the outlook, we see the outlook as being positive. Our economists are expecting a relatively sharp increase in policy rates and that should support our NIM going forward. As Benedikt mentioned, net fees and commissions, really a very strong quarter there, historically strong. In fact, we need to go far -- very far back to see total commissions reaching this number. Effectively, we've seen -- it's not a one-off. We've seen -- for the past 6 quarters, we've seen this rise steadily, which is a great positive. Also, if we look at the last 9 months versus last year, in fact, basically, all our fee sources are increasing -- all our main fee sources are increasing year-on-year, which is a clear positive as well. This we -- we see this as reflective of our new strategy, of course. And again, the diversity in our business is reflected in this quarter. Of course, the driver of the fee business over the past few quarters has been the CIB business and continues to be so, and we see a very strong pipeline there. But as you can see, there was a slight reduction in that quarter, seasonality. But then on the other side, we saw a very strong quarter in asset management this quarter. So a key highlight.In terms of the insurance business, strong -- solid growth year-on-year, 9.4%. And the insurance operations of that business as defined in the combined ratio remains strong, reflective of the strong life business within that insurance company. So an 85.5% combined ratio in the quarter and 91.7% over the year. In terms of financial income, again, very strong quarter, driven by our equity holdings. Important to note that, mentioning Vördur earlier, roughly half of the financial income this quarter came from Vördur through their equity holdings mostly. Of course, Vördur, our insurance being -- insurance company, part of the core operations of an insurance company is investing their funds. So us having an insurance company and that being a growth area for us, this line will, by definition, be a bigger than for some of our competitors in the banking space, which do not have an insurance company.Operating expenses, of course, in terms of cost income, very strong, reflective of the income side of the business being very robust. Also on the operating expenses side, I think we're defensively strong. It's relatively flat year-on-year if we sort of take out one-off items in the salaries, namely around redundancy payments this quarter. So -- and I think we're seeing, as you can see in the other operating expenses, there's a good trend in some of those key items in IT expenses, for example, and housing costs. And we see further improvements in the housing cost line as the Vördur insurance team, as Benedikt mentioned, will be relocated to this office later this year.In terms of the balance sheet, so we saw 11% growth in the balance sheet this quarter. I'll go into more details on the following pages. So just quickly on the funding liquidity side, continues to be very strong. The LCR ratio is 221% and 152% in terms of Icelandic kronas.So in terms of loans to customers, as Benedikt mentioned, we saw -- this quarter, we saw continued growth in the mortgage side, which has been a trend over the past 1.5 years roughly. So the mortgage business has grown by 22.6% year-on-year. The difference now this quarter is that we actually saw an increase on the corporate side as well, which is, as Benedikt mentioned, a reflection of our economic outlook and the fact that we're seeing appealing lending opportunities in the corporate space again. And so -- but effectively, just on the mortgages again, the portion of mortgages in our total loan portfolio has gone from around 40% at the end of 2019 to just under 50% this quarter. Diversity continues to be very strong within the loan book.Deposits again strong story, 14.2% growth in our core deposits year-on-year. And that's, of course, just looking at the loan-to-deposit ratio has supported our overall funding mix. At the end of 2019, our loan to deposit was 160%. That's come down to 140%. And if we exclude mortgages business, which are funded by covered bonds, the ratio has come down from 130% to 107% over the period. Again, strengthening our overall funding mix and making the business more robust going forward.In terms of borrowings, of course, we had a lot of activity this quarter. We had a EUR 300 million senior green bond in July. And then, of course, as Benedikt mentioned, our inaugural euro covered in September, EUR 300 million again. Those were partly to repay upcoming maturities. We have a EUR 200 million senior maturing in December and another NOK 750 million in early next year. So as you can see on the maturity profile, when we repaid those, we effectively have no near-term upcoming maturities outside of sort of Icelandic krona covered bonds and a very healthy overall maturity profile going forward.In terms of capital, Benedikt covered this, of course, to some extent. We saw a common equity tier 1 ratio coming down from 22.7% to 20.9% during the quarter. Of course, reflect -- we see this as a positive milestone on our way to optimizing the capital structure. Again, we paid out ISK 25.5 billion over the year in dividends and buybacks and, of course, have an approval now for ISK 10 billion additional buybacks, of which ISK 5 billion we're launching today. And the leverage ratio, of course, continues to be very healthy in terms of European context, reflective of our standardized risk-weighting methodology.So just tying this together, very robust operational trajectory, very strong quarter, of course. The growth in our fee business especially a positive and reflective of the strategic direction. We see the improving economic climate further supporting our outlook and should support, as Benedikt mentioned, higher profitable loan growth in the medium term. Strong deposit inflow and broadening of our funding options through our inaugural euro cover bond further strengthens our funding profile. And again, given our capital position, while it has been optimized, it has some way to go to reach our 70% target. So we remain committed to that target. And the ISK 10 billion buyback, which I mentioned, is a key part of that going forward.And then finally, as Benedikt mentioned, we have very exciting strategic projects ongoing, which, again, we see as further supporting our outlook going forward. So on that, I again hope to see most of you on our Capital Markets Day on the 17. I will now hand over for Q&A and hand over to the moderator.

[Operator]

[Operator Instructions] We have a question from Maria Semikhatova from Citigroup.

[Maria Semikhatova, VP & Analyst]

I have several questions. I think I'll go one by one. First, on net interest income. You mentioned that you are seeing your margin within the range of 2.6%, 2.9%, assuming that the policy rate stays unchanged. Just wanted to check, you're now running extra funding cost because you prefunded upcoming maturities, so -- and you're repaying liquidity that is putting pressure. Just wanted to check what could actually bring margins lower from the level for this quarter? And also, could you remind us the impact of a 25 basis point hike on your NII?

[Benedikt Gislason, Chief Executive Officer]

Yes. If I maybe start, the NIM percentage point calculation is obviously impacted by the fact, as you mentioned, that we have had a relatively high interest-bearing asset pool at the end of the quarter because of the issuance of the EUR 300 million covered bond. And -- but still, the net interest income in krona terms is flat-to-slightly down by 1%. And as we provide the bridge in our presentation on sort of the main impacts, which is primarily driven by the fact that inflation is not contributing as much to our net interest income as it did last year because the imbalance between assets and liabilities in CPI-linked instruments has shrunk considerably, and that is clearly impacting our net interest income, both in krona terms and the percentage as well. On the other side, the interest hikes will contribute to -- will lead to higher net interest income going forward. Ola, do you want to elaborate on the sensitivity of...

[Olafur Hrafn Hoskuldsson, Chief Financial Officer]

Of the inflation?

[Benedikt Gislason, Chief Executive Officer]

Or the 25 basis points.

[Olafur Hrafn Hoskuldsson, Chief Financial Officer]

I don't have at hand.

[Benedikt Gislason, Chief Executive Officer]

No. No, we -- I don't think we have...

[Olafur Hrafn Hoskuldsson, Chief Financial Officer]

We'll get back to you on that.

[Benedikt Gislason, Chief Executive Officer]

Yes, we'll get back to you on that. But it's clearly kind of -- will contribute to higher net interest income. But whether it outweighs the inflation component, and that is worth mentioning, there is -- the difference between assets and liabilities has shrunk considerably, and we are now at a ISK 10 billion or a little lower ISK 10 billion CPI imbalance, which is considerably lower than a year ago.

[Olafur Hrafn Hoskuldsson, Chief Financial Officer]

CPI balance has come down from ISK 135 billion when it was the highest a few years ago. So I mean, of course, it shouldn't -- like you might say, the inflation effect comes through the rate increases when the change in portfolio has come from CPI linked to becoming mostly floating interest rates. So as I said, there's a transition effect, I think now.

[Benedikt Gislason, Chief Executive Officer]

It is. And it's probably impacting more than -- or the impact is more than kind of in last few years because the real policy rates have been very negative due to high inflation and very low interest rates.

[Maria Semikhatova, VP & Analyst]

Okay. I hear your point. So for me, the outlook is quite conservative, this 2.6%, 2.9%. If you take into account the very low impact of inflation balances, right, and you expect the hike, so the guidance should be towards the high end of this range. But I understand and I would appreciate if you come back on sensitivity. On the fee side, it was very strong in asset management, and you mentioned that there were quite substantial performance-based fees. So if you could quantify that, just kind of to get the underlying trend.

[Benedikt Gislason, Chief Executive Officer]

Yes. So some of the funds that Stefnir is managing are kind of performance related. And due to monetization of certain assets, there was a performance fee accounted for in the quarter. And obviously, these -- it's hard to predict these income lines, but it's definitely a part of the business of Stefnir to earn kind of these fees through managing alternative investment funds.

[Olafur Hrafn Hoskuldsson, Chief Financial Officer]

Yes. So I mean you can sort of look at the -- these are -- definitely, you can say these are one-offs, of course. These are fees on -- mostly from the private equity funds. And you can see from the sort of trend in the asset management line, this goes from around ISK 1 billion to ISK 1.2 billion up to ISK 1.6 million now. That's roughly the success fees change line.

[Maria Semikhatova, VP & Analyst]

Great. Okay. That's clear. And then maybe on insurance, given your structural changes, I think your previous ambition was to kind of steadily grow the contribution from insurance around 5%, 10% per year. Is there any kind of aspirations that you can share with us kind of given the new push?

[Benedikt Gislason, Chief Executive Officer]

Yes. We are in the midst of our business planning cycle, and hopefully, we can sort of give better guidance on this in our Capital Markets Day. It's certainly an event that is fitting for kind of providing further clarity to this. But as I said earlier, we've identified significant bancassurance opportunities there. The bancassurance ratio is still relatively low. And also by offering the shared services of Arion, Vördur is able to grow more quickly than kind of without that support. And it takes -- it's complicated to grow a financial company in kind of double-digit growth for a longer period of time. So we're hoping that by offering these shared services, Vördur can continue to grow. It's been the fastest-growing insurance company in Iceland, albeit the smallest. And we have ambition to sort of move Vördur up the rank in terms of size.

[Olafur Hrafn Hoskuldsson, Chief Financial Officer]

Yes. I don't think we're updating the guidance on the growth now. But we are in the middle -- like Benedikt mentioned, we're in the middle of the planning phase. I mean we see a lot of opportunities on the distribution side, specifically. I think on the -- for the bank, our distributions have gone from 25%, 30% a few years ago digitally to 75% today. And on the insurance side, digital sales are far behind that. And I think we were -- the aim here is to utilize this expertise that we'll build up over the past years to assist our growth of Vördur going forward. But again, it's difficult to put a number on that today, but we see definitely opportunities there.

[Maria Semikhatova, VP & Analyst]

Understood. And maybe you can provide a bit more at your Capital Markets Day. Just final question from me. I've seen that headcount increased 3% quarter-over-quarter. Just maybe you could provide more details where you added resources. Is it because of the structural changes? Or kind of how you think about headcount going forward?

[Benedikt Gislason, Chief Executive Officer]

Yes, it's primarily kind of temporary recruitments kind of due to certain projects. So -- but our kind of permanent FTE headcount is still declining gradually. But it's -- yes, it's sort of -- obviously, when things are going well and we are increasing our revenue pool, you need more people around.

[Operator]

[Operator Instructions] We have no further questions, so I will pass back to the speakers.

[Benedikt Gislason, Chief Executive Officer]

So if there aren't any more questions on the telephone line, maybe we open up to questions here locally in our auditorium. Anyone who wants to come with a question here? Okay. If not, then we thank you all for listening in and look forward, hopefully, to see you all in our Capital Markets -- on our Capital Markets Day on the 17th of November. Thank you.

[Olafur Hrafn Hoskuldsson, Chief Financial Officer]

Thank you.