Arion banki hf

ICEX:ARION

Earnings Call Transcript 2019-Q4

[Benedikt Gislason, Chief Executive Officer]

Good morning, everyone. I would like to welcome you to the presentation of our fourth quarter results and full year results for 2019. My name is Benedikt Gislason. I'm the CEO of Arion Bank. Today with me will be presenting Stefan Petursson, who is the CFO. And afterwards, we will be taking questions from the podium. Now I'm very pleased to deliver the results of the fourth quarter as they demonstrate that during that quarter, we saw a clear indication that the organizational and strategic changes that we made at the end of the third quarter are delivering results. We reported earnings from continued operations of some ISK 5.2 billion, which was a strongest quarter in 2019. We had a net interest margin of 3% in that quarter. The credit risk as a -- the net interest income as a ratio of the credit risk was 4.9%, which was up from 4.5% in the third quarter and, again, our best quarter for the year. And operating expenses were down in the quarter as well. So overall, we were delivering strong results from the continued operations in the fourth quarter. And if we look at the continued operations for the full year, we had earnings of some ISK 14 billion, which is a significant improvement. The -- if you compare the like-for-like in return on equity, it's up to 7.2% from 4.3% in 2018. However, we continue to have negative developments in businesses held for sale, which reduced our earnings to some ISK 1 billion full year, and we say it's not going to reflect our future performance. And I think it's important to note as well that the -- this is not impacting our capital position. We are ending the year with a 21.2% common equity Tier 1 ratio, and that includes actually the proposed dividend for the AGM of ISK 10 billion and the estimated share buybacks until the AGM of some ISK 4.2 billion. And that leaves us with a surplus capital of ISK 16 billion at year-end, including the distributions that we've already announced -- or, sorry, excluding those capital releases. And this morning, we were announcing that we're going to go on the road with additional Tier 1 issuance, which, as you can -- we'll see from Stefan's presentation, will change the composition of our capital if we go out and successfully sell it, which will leave us with further surplus capital in the CET 1 bucket. Now the balance sheet, as you noticed, reduced strategically, we say, last year as we paid down some expensive debt. We paid down the covered bond 2, CB 2, which is also our most expensive covered bond issuance. And we also repurchased EMTN bonds. And then we got repaid assets that were yielding subpar returns, and that is the primary reason for the strong quarter. Now despite the reduction in the balance sheet and the risk-weighted assets, we had quite an active quarter. As we say in the press release, we did some ISK 24 billion of new lending in the quarter, ISK 10 billion to individuals and ISK 14 billion to corporates. And that reflects our new emphasis on capital velocity and using our capital to do more business throughout the year and not necessarily acquire everything and hold to maturity. So we're -- our balance sheet is now sort of turning itself around quicker than before. Now our sort of nonbalance sheet-related activities were strong and activities that we tie up much less capital. Insurance business was quite strong in the quarter, as I'll show you in the next slide. But also, services provided to our clients, we're delivering very good results. Our asset management returns or returns in -- of assets under management, were very good last year, one of the best years in the last 5 years, and we continue to retain our leadership in equity tradings for the fourth year in a row. Now towards the end of the year, we introduced a new environmental policy, and we will be putting increased emphasis on sustainability both in our own operations but also in lending. And I think I covered most of the capital-related points, but the dividend that is proposed for the AGM represents -- or corresponds to some 6.4% dividend yield on the market cap at year-end. And in addition, obviously, we are executing buyback of our own shares, and it's evident, based on our capital position, that we will be in a position to continue to do that throughout the year. Now if we look at four key revenue divisions or income divisions, like I said, the insurance business was doing very well last year, return on equity of some 25%. Our mutual fund business strong as before, a little less than 40% ROE there. The new strategy in CIB, Corporate & Investment Banking, is paying -- is already paying off. And as you can see from the risk-weighted asset allocation, that -- this is the business that consumes most -- the highest portion of our capital, and that's why it's so important to improve the capital velocity and the returns in that business. This is the element that will change our earnings the most and has been a laggard previously. And I'll come to the -- there was a mentioning of our digital leadership in the market, and it's -- it was good to see that last year, we had more active app users for the first time than in the [ net ] -- bank. And we are now with a digital sales ratio in our retail banking offering of some 68%, and we recently saw a benchmark from Finalta, a subsidiary of McKinsey, where it basically demonstrated us as being one of the leaders in the digital space globally with one of the highest digital sales ratio seen. So this has been a success and has enabled us to rationalize our branch network, and visits to branch continue to go down. Now we've been very focused on sustainable and responsible banking. And I'm not going to dwell on all points here, but I think it's important to note that in December last year, as I mentioned earlier, we adopted a environment and climate policy. We're focusing on sustainable development and green infrastructure, and this is something that will be a work -- ongoing work throughout the year as we will evaluate our loan portfolio and -- according to the green criteria and set ambitious targets. And also, we will be evaluating our suppliers and their environmental and climate policy. Now our tax footprint is quite meaningful. As you can see from the pie chart on the right-hand bottom side of the graph, we had a tax footprint of some ISK 16 billion last year, which is equivalent to some 2% of the overall revenue of the Treasury. And if you just look at our corporate tax of ISK 11 billion, that represents more than 8% of all corporate taxes in Iceland. Now before handing over to Stefan, I would just briefly want to go through the macroeconomic situation. It is obviously a concern to everyone these days not just in Iceland but globally as it's evident that things are slowing down. But I think there are some strong fundamentals to -- going for Iceland that will enable us to tackle this downturn in a better way than we have previously. One thing is that savings rates continue to be quite high, and you can see that from the contraction in import being higher than exports last year. So that was a positive contributor to GDP growth. And also, as you can see from this slide, different to other downturns, we have had a fairly stable exchange rate for the last few quarters, and that has enabled the Central Bank to lower its policy rate much more than they have been in previous downturns. And that means that the adjustment that this economy will go through will not go through -- come through the depreciation of the krona, the exchange rate, but rather through the unemployment rate. And that's why we're seeing the unemployment rate ticking up, and it's expected to peak this year. But what is also interesting to see is how drastically inflation is coming down as well. And that, again, has enabled the Central Bank to lower its policy rate. So the sort of the pillars -- key pillars to our economy are much stronger than in previous downturns. And if you add then the debt position of households and corporates and our external net debt position to the equation, they're not sort of major concerns from a credit quality perspective for a bank in Iceland to operate in. And we continue to operate in an economy with a high GDP per capita situation and a historically low debt position. And now I will hand over to Stefan Petursson.

[Stefan Petursson, Chief Financial Officer]

Good morning, everybody, and thank you, Benedikt. I'll take a few minutes to talk about our financials in the fourth quarter and for the full year. It's actually quite interesting that we had a profit of ISK 1 billion, and we are quite pleased with the performance of the bank. But that is actually the case because we saw -- as Benedikt said, we saw sort of clear signs that the revised strategy is already positively affecting the bank. We are seeing our ROE on continuous operations above 10% in the quarter. There are some favorable items in that. We see NIM improving to 3%, lower OpEx and revenues on RWAs are actually closing in on our target. At the same time, we have had robust balance sheet management and RWA reduction, freeing up capital. And we are working on our funding costs, prepaying expensive debt, buying back senior bonds, buying back our shares. So good management of the balance sheet. And the only negative, so to speak, in the quarter is the -- are the effects of the discontinued assets that are affecting our net earnings. We're often asked about Valitor. We are doing some serious restructuring at Valitor to get that into positive EBITDA territory. And the aim on Valitor is very much to continue with that sale. Looking at the income statement then, we are seeing, as said before, very positive trends in continued operations. We had a profit of ISK 5.2 billion in the quarter, which is up 104% from last year. Going up and looking at the net interest income, here we are seeing a slight decrease, but that's only because the -- of two factors: reduction in our loan book; and actually, we had less inflation in this quarter than we had in the same quarter last year, and that affects our net interest income. On the commission side, we are seeing a small reduction. Here, we have quite high ambitions. We have talked about increased capital velocity, and we will strive to increase our commissions going forward. Insurance is strong, and we'll see that especially on a yearly basis, but there is a lot of seasonality on the insurance income side. Financial income, we say, is sort of back to normality. We had a very tough fourth quarter last year. So we are now closing in on our run rate. And other operating, we can say the same. But all in all, this means that operating income is up 7% on last year. We are seeing a substantial decrease in salaries, obviously. We did a large exercise at the end of the third quarter, and we are seeing the results of that. So salaries are down 14%, which is quite impressive. We are seeing, however, an increase in other operating, and I'll talk about that later. But all in all, operating expenses, they are down 2%. The bank levy is unusually low in the fourth quarter. Again, we are managing our balance sheet, and we are managing the liability side, somewhat down in the fourth quarter. And that saves us on the bank levy, which is calculated at the end of the year on the liabilities of the bank. The impairments are positive. And we had announced this before the results, we sold a large mortgage portfolio to the Housing Financing Fund, and we were able to release discounts on that portfolio, positively affecting our impairments. So earnings before tax are up 100%, ISK 6.1 billion. The tax footprint is relatively low this quarter. And again, as I said, ISK 5.2 billion in profit from continued operations. The negative thing is the discontinued operations where we cleaned house a little bit and resulting in net earnings being negative ISK 2.7 billion -- or ISK 2.8 billion, actually. But I'll stress what Benedikt said, that the capital effect of those discontinued operations is very limited as we're impairing tangible assets. The income statement for the full year is pretty much the same story. We are seeing an increase in the net interest income because for the most part of the year, we had actually higher or bigger -- we had a larger loan book that came down in the last 2 quarters. Commission income is slightly down; other sort of revenue items, relatively stable. But operating income is up some 4% year-on-year. OpEx is actually up year-on-year, but we should keep in mind that we took a one-off charge relating to the redundancies in Q3 of ISK 1 billion. So if you compare like-for-like, then OpEx is down. And again, bank levy down due to our management of our balance sheet. The impairment is unusually low. We need to be fair on that. But net earnings before tax is up some 37%, and net earnings from continued are up a massive 57%. So all in all, looking at the core business of the bank, it is improving. But then, as before, the discontinued line is the one that is difficult and results us in having net earnings of only ISK 1.1 billion. I just want to talk about the net interest income because we are very proud of our achievements on the net income -- net interest income side. I mean we are able to increase the net interest margin to 3%, which is the best we have had for quite some time. And we are doing that at the same time as we had -- have very low policy rates. So some of our deposit stack is pretty much at 0. We had very low inflation, 2.3% compared to 4.2% in last year. And we have been issuing Tier 2, so we've been issuing quite expensive capital instruments. And in spite of all of this, we are able to increase our net interest margin, which shows that we are doing the right things on the lending and investment side. We see, on the right-hand side there, how we have reduced our credit risk. And we have done that in -- like we say, in a strategic manner, mainly on the -- well, actually, both on the corporate side and the retail side. But we are seeing revenues -- our net interest income on average credit risk increasing quite drastically, another very positive sign in our operations. And on the bottom, we see sort of what is creating all of this. And if we look at the bridge between '18 -- Q4 of '18 and Q4 of '19, it is basically that the reduction in our loans to customers is more than offset by reduced deposit costs and reduced borrowing costs. And then on the negative side, inflation being lower this year brings down our net interest income. On the OpEx side then, we are doing most of the right things, I think it's fair to say. We are seeing positive trends in the cost-income ratio, where our target is 50% and we are trending towards that. Clearly, on the salaries side, we are seeing very positive effects. And we can see that in the number of staff, almost 800 down to 690 year-on-year. So the salaries cost are coming down. At the same time, we are seeing some increase in the other OpEx. Part of that is understandable when we are outsourcing something that we did in-house before. But we need to -- and we will take a very close look at our operating -- other operating costs. IT is actually one of the areas where we will concentrate going forward. But again, the trends are in the right direction. On the balance sheet side, I mean, I think this slide shows very well what we are talking about. We have reduced both loans to customers, which represent more than 71% of our balance sheet, which, as always before, is simple and strong. But we have also reduced liquidity, and we've used that liquidity to buy back expensive debt. Regardless of all of this, we end the year very strong, very liquid. Our LCR ratio is almost 190%. And our ISK LCR, which is, I guess, the more important for us, is almost 160%. So the bank is in a very good position to support its customers in good projects. The loan book, as we say, it decreased by 72% -- 7.2% during the year. But what is interesting and good to see is that even having sold the mortgage portfolio to the Housing Financing Fund and having sort of strategically reduced corporate loans, our balance -- or the split between individuals and households remains stable, which we believe is very good for the bank. And at the same time, loans to the corporate customers in a way mirrors the Icelandic economy, which is something that we feel is very normal for a large bank in Iceland. On the liability side, we have seen some very interesting things taking place. And I think the big message here is that deposits are now on -- they are increasing in our funding mix. With the reduction in our loan book, we have been able to repay wholesale borrowing, which are more expensive than deposits. So this is positive. This is very positive for our NIM. Clearly, the equity position is very strong even if we have been active on the equity side with both dividends and buybacks. And deposits are -- they are increasing. And I think we have a -- we don't have a slide on that. We should not read too much into a small decrease in deposits at year-end. Simply, the bank is sort of trying to be careful when taking on deposits there for year-end because, again, the size of the liability side affects our bank levy. Borrowings, they have come down, as I said. And where we have been active is on the Tier 2 side, and we've been increasing that. We will continue to issue covered bonds in the domestic market. We will look at senior issuance this year as well. But our focus, as Benedikt said, right now is on AT1, and we hit the screens this morning with a potential trade in AT1 over the next week or so. That goes directly into our capital, and our capital position is very, very strong. We actually have a capital adequacy ratio of 24%. And here, our proposed dividend payments and share buybacks until our AGM are already taken into place. The composition has changed slightly from the last quarter where CET1 is down slightly to 21.2%. But we have issued Tier 2, so that is at 2.8%. We have also been reducing RWAs, and that feeds into our capital position. And all of this, because our risk weight density is very high, again, feeds into our leverage ratio, which is over 14%. And that's always -- we want to put that into context. This is about twice the leverage ratio of DNB, which is by far the strongest in Scandinavia. So the bank is very, very strong. Now what this means is that when we look at our own targets on capital, which we have changed our management buffer, it is now between 100 and 200 basis points, was 150 basis points actually before the Board meeting yesterday. And this means that our capital target, including our buffer, is between 21.3% and 22.3%. We are at 24%. So we have around ISK 16 billion of surplus capital as it is. We can issue AT1 sort of up to around ISK 15 billion. So there is ample -- more where this came from. And this takes into account our ISK 10 billion dividend proposal. So the scope for the bank to release capital is quite substantial. It should also be mentioned that we expect, and we are actually -- well, we know that the FME will ease requirements relating to SMEs. So we will gain another 40 basis points on that, meaning that the bank has ample capacity to reduce capital. And in a way, we are stocking up our guns to continue on that path. Our targets, they remain unchanged. Again, return on equity, over 10%; revenues on risk-weighted assets, over 6.5%; cost-to-income, 50%. And then the loan growth, as we have said, we expect a reduction in the loan book over the near term. And from then on -- and this has been misinterpreted in the local context. We are not trying to lower the loan book forever. We want to readjust it and grow from there. And then now our CET1 target is 17%, down from the 21.2% we have now. And finally, the dividend policy is to pay out 50% of net earnings, and then extraordinary payments when we have the capital to do so. And looking at our net earnings of ISK 1.1 billion, we are paying quite a bit of extraordinary dividends after our AGM. And I'll close with the outlook. And there's no coincidence that we had a target before this one because we are very focused on our targets. We feel we are closing in on them even if it might look differently. We are concerned about the macroeconomic environment and, in a way, more globally than locally. But global issues, they will feed into domestic issues. We will continue the decrease of RWAs. As I said before, the focus is on operating expenses, and that goes for banks everywhere. The sale process of Valitor continues. And when we wrote this -- when we issued this yesterday, then we were aiming to issue AT1. That is still the case, but we have hit the market already. So this is my final slide. We will now turn to Q&A, and we will have Mr. Benedikt Gislason, CEO, come up here again; and Eggert Teitsson, Deputy CFO; Theodor Fridbertsson, Head of Investor Relations. And we'll start off with questions from the phone. So gentlemen, please.

[Operator]

[Operator Instructions] The first question we have is from the line of Martin Leitgeb from Goldman Sachs.

[Martin Leitgeb, Analyst]

Yes. Thanks for the presentation. I have 3 questions, if I may. And the first one, I was just wondering if you could give us an indication on how the repricing or management of that part of the covered loan book is going, which you highlighted back in the November Capital Markets Day, and I think the expectation was either to reprice or to manage out some of the low-yielding, nonstrategic relationships. And I was just wondering how that is progressing. Do you see majority of clients taking up the offer or moving somewhere else? And in that regard also, how the competitive landscape is evolving. Do you see other bank in Iceland doing the same? Or is this pretty much an effort from Arion Bank alone at this stage? The second question is just thinking a bit further in terms of capital and capital distribution. So the message here being, if I understand you right, that you aim to get to the 17% target as quickly as possible. So is the next milestone then here AGM, where the dividend gets approved, and then we have to wait for another year? Or at which intervals would you consider extraordinary capital returns with quarterly earnings qualify for you to reconsider an increase in buybacks or similar? And finally, on capital AT1 issuance you have launched, that has essentially implied that you're quite comfortable that the tax deductibility on this AT1 capital is going to happen? And final question on the return trajectory. So you stated return target of 10%. Obviously, 2019 was impacted by the for-sale assets. Could you give us any steer on how we should think here on the trajectory from 2019 to your 10% target? Would you -- is there any way you could give us a range either for this year or what the main building blocks are?

[Benedikt Gislason, Chief Executive Officer]

Thank you. Very good questions. Let me start by trying to answer some of them, and then I'll hand over to Stefan. The repricing of the corporate loan portfolio is going according to plan. And I think it's fair to state that the other banks are following in our footsteps there. I think the whole market realizes that the -- it was unsustainable pricing towards the end of a fairly hefty, competitive market, which was driven by a dramatic increase in the capital base of all the banks without any capital release as the owners didn't really want to receive any capital out of the banks a few years ago. And this is a continued effort, and we will see further impact of that at least in the first half of this year. And as we've communicated before, there's a decent portion of the loan book that has a repricing capability within the 12-month scope because of interest rate resetting or, in some instances, because of inbound requests from clients to waive some covenants or change the structure of the loans. I think it's also fair to state that the involvement or issuance of bonds in the covered bond market hasn't really taken off. But we're seeing in the investment strategies for this year that we've heard of from the pension funds that they are aiming to increase their portion of covered bonds by a meaningful amount. So that gives optimism that we will see the demand for these instruments this year. On the 17% CET1 ratio, I think it's fair to assume that we will continue with the buyback throughout the year, and we might have to look at other ways of buying back shares if the sort of current practice, which limits us to 25% of the volume in the stock exchange, does not enable us to distribute as much as we want. And for us, in a low interest rate environment, as Iceland has become, it doesn't make any sense to hold on to the capital at low yields throughout the year. So we will probably have to look at, yes, tendering some of the shares or call for an AGM to do another dividend payment. On the tax deductibility of the additional Tier 1, yes, we're pretty confident that, that bill will go through. But -- and we've seen additional commitment from the Ministry of Finance through a press release at the beginning of January where they named this as one of 5 items that they are either working on or have implemented to improve the operating environment for banks in Iceland. So yes, that's -- we're assuming that, that will be approved. On the trajectory of our earnings, I think we provided some guidance to that in our last quarterly presentation and in the Capital Markets Day. And obviously, we have our -- we have a financial target of reaching 10%. And my personal [ opinion ] would be to see that happening towards the end of the year. But we've sort of -- we -- I guess it depends a little bit on the operating environment and the macroeconomic situation in Iceland.

[Stefan Petursson, Chief Financial Officer]

And we don't want to give too much specific guidance on that, but I think you should very much look at the trends in our business or in our ordinary business, where we're seeing positive trends on the revenue side that we believe will continue. We've seen positive trends on the cost side that we believe will continue. And as Benedikt says, releasing equity or releasing capital will also have a positive effect. So in a way, use the trends to do your model.

[Benedikt Gislason, Chief Executive Officer]

As it goes to the assets held for sale, we -- as before, we're putting a lot of effort into the sales process of these assets. And I guess sort of -- we're certainly hopeful that, that will result in the sale of these assets. But that, again, sometimes depends on external situations that we can't control.

[Operator]

[Operator Instructions]

[Benedikt Gislason, Chief Executive Officer]

Should we maybe -- if there aren't any further questions from the webcast, should we maybe turn to the auditorium? Well...

[Stefan Petursson, Chief Financial Officer]

Moderator, are there any further questions from the telephones?

[Operator]

At this time, there's no further questions on the audio.

[Benedikt Gislason, Chief Executive Officer]

Okay. Any questions from our guests here today? Okay, I guess not. Then we thank you all for showing up and listening to the presentation. And looking forward to seeing you in 3 months' time. Thank you.

[Stefan Petursson, Chief Financial Officer]

Thank you all.