Arion banki hf

ICEX:ARION

Earnings Call Transcript 2020-Q4

[Benedikt Gislason, Chief Executive Officer]

Good morning, dear guests, and welcome to this webcast presentation of Arion's fourth quarter and full year 2020 results. Thanks for tuning in. We will be here today going through the investor presentation of our fourth quarter results and 2020 results. And I'm joined with Stefan Petursson, CFO; and Eggert Teitsson, Deputy CEO here. And collectively, we will go through this together.Now the fourth quarter was the third quarter in a row where we showed a meaningful improvement in core operations of the bank. And indeed, this was the best quarter in over 3 years with return on equity above 10% target and actually closer to 15% on the optimized equity, which is the equity that we intend to use in our business. And this gives us great comfort to come here today and provide an updated guidance on financial targets for the next few years, where we are raising the bar a bit and also providing a strong guidance on further capital release on top of the ISK 18 billion that we are announcing as well. This is driven by a solid income growth of 8.2% in the quarter but also a tight control on costs, and the measures that we took in 2019 are paying off. So there is an improved operating efficiency across the group, which is demonstrated in the cost-to-income ratio.We're also benefiting from the fact that we have a really diversified income stream from different financial services and have invested heavily into distribution channels, which are paying off in terms of cost, in terms of ability to service clients and to deal with the situation like we had last year where we had our branches closed for 19 out of 52 weeks.I mentioned the capital release. So the Board yesterday, when it approved the financial accounts for last year, they're proposing for the AGM a ISK 3 billion dividend payment and also approved a ISK 15 billion share buyback program, which we expect to initiate in the coming days. And this is on the back of the regulator approving such a measure.Despite the ISK 18 billion of capital releases, we still have one of the highest CET1 ratios in Europe. There is a ISK 40 billion surplus capital on top of a pretty sort of substantial management buffer at the moment. And that gives us, alongside with much stronger capital generation in our core operations, great comfort to guide for a further ISK 50 billion capital release in the coming years. We have, obviously, been sort of in our journey, benefiting from the fact that we have a pretty sort of diversified shareholder base and strong access to capital markets. And last year, we used that to issue the additional Tier 1 instrument and have now completely normalized our capital structure in a way that we have the optimal structure going forward. The only issue now is to release some of the surplus capital that we still have.I mentioned the organizational changes in 2019, which are the main contributor for this improvement in performance. And we have taken that further by revising our strategy a bit, which was approved by the Board of Directors in December. And it builds on a journey the bank has been taking in recent years, builds on our culture and values and the shifts in focus, which were introduced in September 2019. And the positioning is such to excel by offering smart and reliable financial solutions, which create future value for our customers, shareholders and the society as a whole, built on 3 key pillars, where we are really focusing on being a solutions-oriented and performance-driven entity. And we've already begun to implement the strategy, as you saw from our recent announcement on the newly introduced variable remuneration scheme, and this will shape our business and services over the coming years.Now Iceland has, in many ways, been successfully dealing with the COVID-19. And I'm sure that you're all following sort of the coloring of countries in Europe, where Iceland is currently the only green country with a really low new incidence ratio or rate. But apart from that, sort of the social fabrics and the resilience of households, corporates and the public sector as well has enabled the country to deal with the downturn, economic downturn in a pretty strong way. One of the sort of fiscal measures that was taken was the massive reduction in policy rates, which is now paying off in terms of mortgage refinancing, where market refinancing is at all-time high. And in some instances, borrowers are reducing their borrowing cost by more than 30% by refinancing. So that is really helping with disposable income.It's interesting to see the traffic data, which demonstrates that there was -- apart from the complete lockdown in March and April of last year, things have been quite normal. And if you look at the consumer goods imports, they're actually up 5% between 2020 and 2019. So whilst Icelanders are unable to travel abroad, they are definitely consuming. And this is supported by strong fiscal measure and monetary measures, which are holding up the disposable income.And that's why we are pretty confident that, combined with, obviously, the vaccination program that we are following, sort of where we basically are following the route of other European countries, is that we will see a rebound in our economy in the second half and on the back of significant monetary and fiscal measures. And as you can see from the general government gross debt position that there is still meaningful room to add to fiscal measures, which have, in international comparison, been sort of somewhere in the middle range. And there is definitely room to do more if the economic recovery sort of fosters.I mentioned the -- our digital services, which really navigated us through the COVID lockdowns, and there, we claimed that we have a leading financial service platform with considerable future potential. We've invested heavily into these distribution channels in the last few years. As you can see from the development of digital sales, they are on the rise, and we have a recent Finastra survey, which puts us among the best-performing banks globally in terms of digital sales. And it's interesting to see the number of interactions, being 42 million last year. 99% of those were through digital channels. That means that we interacted with our clients, on average, one time per day. It's an interesting statistics. And this is also the -- our sort of focus here on digital development or digital solutions is very much supported by or helped by Iceland's strong digital focus in the public sector. And we saw, for example, last year, a lot of new measures taken on the public sector side to facilitate banking services during closure of branches.Now last year, we sought to expand our range of green products. We launched a new deposit account called Green Deposits, which has been used to finance the bank's green car loans. And we also started offering mortgages with special interest rates, green mortgages. And our thinking there is by -- sort of by providing green mortgages, our primary objective is to encourage individuals, construction companies and real estate companies to build more environmental-friendly housing. So here, our approach is very much sort of business-driven.Now before handing over to Stefan, I would like to go through 2 slides, basically the bridge of the earnings, the earnings from continued operations. I did not mention the discontinued operations, which were quite a drag on our operations last year, and we aim to change that and have positive contribution from the discontinued operations, the assets held for sale this year. And if we get that, we can easily meet some of our financial targets, given sort of where we are in terms of our core operations. And as you can see here, if we look at the full year, we increased our revenues, core revenues by some ISK 2.8 billion and, at the same time, reduced our operating expenses by ISK 2.4 billion. And that is the main kind of driver for improvement in core operations.And if you look at sort of where this revenue generation is coming from, it's interesting to see that we were able to hold onto our net interest income despite a much lower interest rate environment. But the real contribution is really coming from our policy or business strategy of focusing on capital velocity and -- on the corporate banking side, where we are almost doubling fees from lending and guarantees between years, a meaningful sort of [ fee pool ], and doubling it was quite an achievement.I mentioned sort of the -- this third quarter of improved operating -- or core operating earnings, giving a reason for revising our financial targets, and we've indeed revised 3 of them now. We're presenting that today. Our biggest change is, obviously, that we have now reduced the cost-to-income ratio from 50% down to 45%, and that effectively represents a really strong focus on expenses, and we have internal kind of targets, which we are not putting out, which will help us achieve this target. But this also represents the fact that we think that there is room to grow the revenue side as well. And that's why we actually increased the revenue on risk exposure amounts from 6.5% to 6.7%, which is a new kind of financial target that we introduced during the Capital Markets Day to represent exactly the new business strategy of focusing on capital velocity. And coming to that, the third change that we make is on loan growth, where we had previously been guiding for a reduction in the corporate book on the back of this strategy, where we now are saying it will probably develop in line with economic growth, but we still anticipate the mortgage book to grow at a slightly faster pace.And with that, I hand over to Stefan Petursson, the CFO.

[Stefan Petursson, Chief Financial Officer]

Good morning, ladies and gentlemen. This was a very good quarter for the bank. It wasn't perfect, but it was very good. If we look at the targets, at the bottom of the page, we met all our financial targets for the quarter, with ROE of 11.8%, operating income/REAs at 8% and cost-to-income ratio at 44.9%.So as we see, a solid quarter, obviously, led, as Benedikt said, by increasing core revenues. NII over credit risk improved year-on-year, and OpEx is under control. And then on top of that, other sort of things, in a way, developed very positively. Balance sheet is very, very strong, regardless of the capital release that we have forthcoming. And we still have ISK 40 billion of surplus capital that we want to distribute to shareholders over the near term.If we look at the income statement for the fourth quarter, as I said, then we see solid growth in core income of 8.2%, but we also see a solid improvement in net financial income where equities, holdings and trading were doing extremely well. And other operating income is also up massively. Here, we are finally seeing the benefit of both sale of assets, but more importantly, by sale and fair value increases in investment properties that the bank holds, which are mainly sort of residential development lots in the Reykjavik area. So operating income is up some 25%. Costs are under control. Even if they remain at target, they are up 3%. Bank levy is relatively stable from last year. And in the quarter, the impairments were negligible. They were basically positive by ISK 74 million. We have improved our modeling. We have done extensive impairments throughout the year. So impairments were not a factor in the fourth quarter, bringing earnings from -- before income tax up by 29% year-on-year. Income tax expense was positive due to the composition of our earnings. So earnings before -- from continuing operations were up from 56% at ISK 8.1 billion, but as Benedikt said and when I said the quarter wasn't perfect, we still have a drag from our held-for-sale assets, something that we aim to reduce and turn around. So the net earnings for the quarter were ISK 5.7 billion, up from a loss in the previous year.Looking at the full year, it is, in a way, more of the same story, positive core income, positive both financial and other income. So operating income is up 6% year-on-year. Expenses are coming down by 9%. We should keep in mind that we had one-offs due to a reorganization and layoffs in September of last year, but still very good trends on the OpEx side. The bank levy has been reduced finally from 37.6 basis points down to 14.5 basis points, and we are, obviously, noticing that in our results. So all the way down to net impairments, we are seeing a very positive story. But then obviously, for the year, we have substantial net impairments due to the COVID-19 pandemic, just over ISK 5 billion. But regardless of that, net earnings before income taxes is up 12% year-on-year, and net earnings from continuing operations is up some 19%. Again, ISK 4.2 billion in -- negative from held-for-sale assets is something we are extremely unhappy with and aim to change going forward.As Benedikt said, the net interest income is showing very positive signs sort of given where we are in terms of base rates. I mean we are at record low interest rate from the Central Bank, but regardless of that, we maintain NIM at 2.9%. I think that shows -- well, it is demonstrated there in the bottom part of the slide -- sort of the bridge that we see what is happening. Basically, we are getting less interest revenue from our customers and from our liquid assets, but that is more than offset by a reduction in the cost of deposits and the cost of other funding for the bank.Inflation and the inflation imbalance that has often been pretty important for us in the bank. So that importance is reducing because the inflation imbalance is reducing mainly with the refinancing of retail mortgages. And as I said before, our income on -- net interest income over credit risk remains relatively stable, and this is a performance target that we look at very closely.Commissions are trending very much in the right direction and, in a way, this slide doesn't show the full picture. I mean, clearly, as we know, some of the volume-related fees are down given COVID, so that's mainly on the retail side. But on the lending side, in lending and guarantees, we are seeing a very positive development, and it is up, as Benedikt said, almost 100% year-on-year for the full year -- to full year. And this is something where we feel that our strategy of capital velocity is really kicking in. The insurance company, Vördur, or the insurance arm of Arion Bank is doing very well. The combined ratio there is very competitive in the domestic market, and this is a very good addition to our business.Cost is and will continue to be a focus. We continue to reduce our number of employees. They're down 6% at the parent company year-on-year. Other OpEx is relatively stable year-on-year. We are seeing an increase in IT costs. We did sort of capitalize less than we did last year of certain set of development, but we are focusing very heavily on IT costs, with the aim to bring those down. We're also seeing an increase in housing costs that is temporary. We're investing in housing. Sort of the reduction in the number of staff has allowed us to close certain facilities and consolidate our operations. So we're hoping to see that trending positively going forward.The balance sheet, as before, is very strong. It's very simple. 70% of our assets are loan to customers. There was a sort of -- shall I say, sort of modest 8.4% balance sheet growth for the year of 2020, and that was led by mortgage lending and increase in liquid assets. And looking at our liquidity, it is very strong with LCR being at 188%. And ISK LCR, which is often or can be a limiting factor in our business, that is 144%. So the bank is fully able to both support customers and distribute capital to shareholders.Looking at loan to customers, it's really interesting to see how sort of low cost of risk and capital-light retail mortgages have been leading the way in 2020. Mortgage lending is up some 21.8%. At the same time, both SME and corporate lending is sort of relatively stable. Corporate lending, obviously, very affected by the capital velocity strategy that we have undertaken.We have a good mix. Now individual lending is exceeding corporate lending as a percentage, and we do have a good sector split in the book. Around 12% of our loan book is affected by COVID. 7% of the book is in tourism or is tourist-related, and that has all been either put into Stage 2 or, alternatively, Stage 3.And our calculated cost of risk is 71 basis point, of which 24.2 bps are due to changes in economic scenarios in our IFRS 9 models. We have been working a lot on those models during the year, perfecting them, hopefully. 24.2 bps are due to specific impairment, that is, Stage 3. Then we have 16.2 bps due to tourism exposure in the credit risk and then 6.4 basis points due to other exposures.We should also note that REAs from loans to customers are relatively the same as it was last year, even if loans to customers have increased by 6.3%.On the liability side, we can see that our equity position is very strong. Leverage ratio is 15.1%, which is, obviously, super strong. We are very pleased with the development of deposits, where we saw core deposits rise by 14% during the course of the year. And deposits are playing more of a role in our funding mix. But on top of deposits, we also have both covered bond funding in the domestic market, where we were relatively inactive last year because we were so liquid. And then we do senior borrowing in the international markets. And there, basically, we issued 1 public bond and used that to buy back, in a tender offer, part of proceeds from a bond which is maturing next year.The capital adequacy is also massive. As we see there on the right-hand part of the slide, our capital adequacy is 27.0% -- is 27%. And the CET1 ratio is 22.3%. And on the right-hand side, we are just showing the effect of our capital release of ISK 18 billion, which now has been put into our calculations. And if it weren't for those, our capital ratio would have been at 29.4%.But looking to the left, it's also interesting to see that we do have a buffer, capital buffer of ISK 40 billion that we aim to distribute. And that buffer is on top of a very, I would say, hefty management buffer, which is now ISK 26 billion and consists both of our own management buffer and the vacated countercyclical buffer that was, in a way, released at the beginning of COVID.So going forward, then we are actually pretty excited to continue on our positive operational journey sort of armed with a -- an updated strategic vision. As Benedikt said, we see continued growth in mortgage lending. We see continued activity in ESG-related both lending and funding. The corporate loans will grow, but the bank will focus on return on REAs as we have been doing. And the best execution for corporate clients is not all about lending, it's about servicing the customer meeting their needs.We feel that economic uncertainty has declined or reduced somewhat. And we feel we have more visibility on our asset quality. I think our impairments are in line with what we've seen in Scandinavia and, hopefully, that would be sufficient going into next year. We are, obviously, committed on our capital release strategy. I mean based on the guidance from the Central Bank, we are paying ISK 3 billion in dividends post our AGM, and we are buying back ISK 15 billion of our own shares. And we think it's actually a very positive sign for the bank and the banking sector that the Central Bank has allowed us to buy back our own shares. Regardless of that, the Board actually might call an extraordinary shareholders' meeting in the fall to discuss further distributions, but that obviously is somewhat linked to the development of COVID.As Benedikt said, we aim to distribute more than ISK 50 billion of capital over the next few years. And as we have said before, sort of given the economic situation, we don't rule out internal or external growth, but obviously, the opportunity need to show themselves, and that hasn't happened so far.So with that, I give the word to the moderator and -- to go into Q&A. Thank you.

[Operator]

[Operator Instructions] Our first question comes from Maria Semikhatova from Citi.

[Maria Semikhatova, VP & Analyst]

A couple of questions. First of all, it would be useful to hear a bit more color on your changed strategy in the CIB. We can see that the segment is still lagging in terms of revenue per risk-weighted assets. Also, [ it was ] much lower. So just wanted to hear, do you see now challenges selling the portfolio to third parties or [indiscernible], which was the previous strategy? Or you now see profitable growth opportunities on the corporate book which were not present before? So that's question number one.Second, on costs, you mentioned that you expect positive trends in both IT expenses and housing costs. More generally, is it fair to assume that you believe that you can bring the nominal amount of costs further down?And finally, on capital distribution, just can you tell us what's the regulatory restrictions still in place? And just maybe your thoughts on potential additional distribution in the fourth quarter. Is there any thresholds you would -- like more clarity on the economic front you would want to see before you make a decision on additional distribution?

[Benedikt Gislason, Chief Executive Officer]

Thank you, Maria, for your questions. The sound broke up a little bit for your first question, but I think I got it. You were asking about the changed strategy in CIB and whether we were happy with sort of the return profile in that business and whether there were some changes ahead. And I think, in all honesty, this is -- so the return or the recovery of that business to us, as a business unit, has exceeded our expectations quite a lot. And we're seeing -- and this is the -- one of the main contributors for the improvement in the core operations in -- especially in the third and fourth quarter. So we are seeing sort of an improvement in net interest margin on the back of repricing of the book.So a lot of activity has been taking place. As you saw in my quote in the press release, we did a lot of lending, even though no new lending, and that enabled us to reprice and, to a degree, charged fees as well and then a lot of sort of activity that doesn't really show up in the [ year of end ] balance as compared to the previous year. So the velocity or the volume going through the -- that unit has increased. And that is on the back of sort of a strategic decision to merge the corporate advisory and sort of have it under the same umbrella, the corporate advisory and corporate banking in a typical CIB format, which is something that other banks in Iceland haven't really been adopting. And that has enabled us to service our clients in a more holistic manner. And we have high hopes that we will continue to see an improvement in that business. That is quite important because, as you point out, it's deploying proportionately the highest amount of our own capital. It's a very capital-intensive business and a key pillar to sort of improving the core operations to get right.Now you've asked about the housing costs and whether we were willing to sort of commit to nominal cost reducing. As I mentioned in my statement here or presentation, we have internal targets. And I think they reflect quite well through the cost-to-income ratio, which we're lowering from 50% to 45%. And there is indeed a cost rationalization program in place, but we decided not to publicly communicate it. But in order to get down to consistently below 45%, there definitely needs to be a strong focus on costs.The -- and then you asked about further capital releases and regulatory environment around that. So whenever we want to buy back shares, we need the regulator's approval for dividend payments that exceed our capital requirements. We're allowed to do that, but there is, obviously, a guidance in place as well here in Iceland as the rest of Europe for a certain kind of dividend payment distribution. So we intend to sort of abide to that or follow that and then take account in the autumn. And if indeed our capital generation or core earnings continue to deliver like the fourth and third quarter, then we're clearly in a really good position to pay an extraordinary dividend in the autumn.

[Stefan Petursson, Chief Financial Officer]

And if I just add to that, I mean, we -- our relationship with both the FSA and the Central Bank is very good, and we like to work with them. And I think that is also demonstrated in the fact that they are allowing the buyback, which is actually quite unique, I think, in Europe at this time for demonstrating that they understand the special situation that Arion Bank has at this point in time.

[Operator]

Our next question comes from Martin Leitgeb from Goldman Sachs.

[Martin Leitgeb, Analyst]

A couple of questions to start with. And the first one on risk costs. And just looking at the unemployment chart you show in your presentation, how much of a front-loading of risk cost has happened in 2020? And how much -- how should we think about the progression in risk costs from today's perspective? And I appreciate there's probably still a lot of risks out there in terms of how things evolve, but how should we think about 2021 risk cost, 2022 risk cost in terms of qualitative progression from here to start with?And second question, you mentioned the ISK 4.2 billion drag from discontinued operations or assets held for sale. Again, given some of the impairments taken during the financial year 2020, could you help us frame how much a drag we should have here?And then third question, just to go back to the updated target, so number one, higher revenues; number two, lower costs; capital unchanged in terms of core Tier 1 ratio and even standardized risk weights. So those shouldn't change. Is there a level of conservatism built into that 10% return target, all else equal, if you compare it to the previous targets or potentially could this [ edge ] high over time?

[Benedikt Gislason, Chief Executive Officer]

Thank you, Martin, for your questions. The first one is a really good question, sort of how -- what have the sort of changes in our credit portfolio over last year done to sort of front-loading, I guess, new exposures that will then represent in different kind of cost of risk going forward? And I think I have a really sort of simple answer for that, which is that if you look at the mortgage portfolio, it's indeed -- almost half of it is sort of new mortgage lending last year, but a lot of it is refinancing, either refinancing existing exposures with the bank or refinancing of clients with other institutions.And if you look at -- there's an explanatory note in the accounts, which breaks down the mortgage portfolio between LTV buckets. And if you compare the difference between the years, you can see that out of the ISK 68 billion in increase, more than half of it is in the LTV bucket of 50% to 70%, which indeed sort of indicates that this is rather a refinancing activity than kind of new housing acquisition done at the high LTV.And we have not -- we have rather sort of made our LTV requirements more stringent when it comes to refinancing. And I think Iceland is running a conservative LTV approach, where sort of first-time buyers are allowed to borrow up to 85%, which is lower than you find elsewhere and then 80% for others. And refinancing LTV requirements we have even lower.There is, indeed -- and that's -- so there is some, I think, ISK 15 billion out of the ISK 68 billion, which is in the 70% to 90% LTV bucket, but most of that is closer to 70% than 90% because, obviously, of these requirements.Now on the corporate side, we talked about capital velocity, which means that we -- I mean we've done a number of deals, but in many cases, we've been syndicating part of the exposures, so not taking on the full risk. But if you read the -- my quote in the press release, there's a sort of -- the activity on the corporate side is really much about servicing existing clients and providing them with sort of rolling over their exposures and things like that. So much of the sort of the risk implied in that book is from long-standing existing business relationships where we have already made loss allowances and have a pretty good overview of the exposure.So I would say that neither of the 2, the mortgage portfolio or corporate book, represent any kind of change in underlying cost of risk. It remains very much the same, and the cost of risk in the mortgage portfolio in Iceland has historically been somewhere between 7 and 9 basis points. We don't see any. And even though the housing prices are on the rise, they are not overly deviating from the rise in net disposable income. And if you then combine it with the lower borrowing costs, I think we're not seeing a real estate bubble yet. And if we indeed see that, then we have the option of even lowering our LTVs further.You asked about the assets held for sale and the drag on those, and that's -- it's very unfortunate, and we're not happy about that. But we -- our plan is to change the course here and have these assets all contribute to the bottom line this year. For United Silicon, [ Stakksberg ], we've taken the value of that property or that facility down to the land -- or the value of the plot and scrap value of the equipment. That reflects the fact that we've unsuccessfully been trying to sell this asset and are now looking at other alternatives. This is a well-situated land close to really sort of good harbor, very close to an international airport. So we're sure that -- and a lot of ample kind of green energy around there. So we're sure that this could be used for other purposes in the future.Valitor is undergoing a restructuring and has demonstrated better performance than in 2019. And -- but that business is, obviously, heavily impacted by the COVID-19 situation. And even though e-com is showing decent or really good growth within the partnership, it's still kind of the volumes, especially due to traveling, both of Icelanders and tourists to Iceland, is impacting the bottom line. And we're hoping that as things normalize and their rationalization program fully materializes, that we will see an improvement there. And obviously, this is still an asset held for sale, and it remains to be seen whether we can monetize that thing.And then finally, our travel agency business, which effectively was taken -- or marked down to a very low value and there, we have partnered up with investors in the industry, and we hold a stake in these companies and are hopeful that once, again, traveling picks up, that these businesses will pick up as well.And then Stefan, do you want to answer the last question?

[Stefan Petursson, Chief Financial Officer]

Yes. Absolutely. Now the final question is, in a way, obvious. As I understood it, we are showing improved targets on revenues and costs. And the question is, should we then look at our ROE targets as well? And I think it's fair to look sort of going forward that the ROE targets could potentially exceed 10%. But we should also sort of link that to our capital release that will take some time, but it's definitely not out of the question. And the same obviously goes for -- with our capital generation. It is not out of the question that going forward, we would also look at our dividend target.

[Martin Leitgeb, Analyst]

Yes. I would have a few more questions. I'm not sure, should I just pause here and rejoin the queue so others have the opportunity to ask first.

[Benedikt Gislason, Chief Executive Officer]

No, while you're on.

[Martin Leitgeb, Analyst]

Okay. So 3 more then, if I can. So in terms of competitive dynamics, I remember when you had the Capital Markets Day back towards the end of 2019, where you essentially laid out your strategy on the corporate book, so either reprice or reduce, and I think you were the first bank with such a move. How has the competitive landscape evolved? A lot of banks essentially, I guess, are likely facing the same return challenge on that book. Have other banks followed the lead and done a similar exercise and that's basically the driver for the improved performance here?Secondly, if you would have the chance to grow, just building on your comments you had before in terms of internal or external growth opportunities, which growth opportunities would you be most excited about? Is this in Iceland, in another product area where you underrepresent that? Or could that be potentially elsewhere? And thirdly, finally, rate sensitivity. So just looking at the inflation chart and where base rates have moved, what have you baked in, in your updated revenue targets in terms of rate hikes? And if you could remind us what the rate sensitivity is? So for one rate hike, what would the impact on NII be?

[Benedikt Gislason, Chief Executive Officer]

Yes. On the competitive landscape, in the corporate banking, we have -- I mean, we've firmly believe that we have the right strategy in place and that is demonstrated in the numbers. And we are seeing other banks sort of flirting a bit with the approach, but no sort of kind of strategic decisions that we've seen. I would say that it depends a bit on sort of whether these banks are big or large. The smaller ones -- small or large. The smaller ones clearly have to think in this way because they're unable to underwrite the whole exposure themselves. And this has led to a more kind of dynamic environment in Iceland, where the pension funds, which obviously have the fortress balance sheet, are getting receptive to the concept of being an investor in this asset class. And we've seen a sort of recent rollouts of credit funds where they are the primary investors. And that is -- it's helpful and brings better balance to this.We've as well seen international banks operating here, and we want to team up with them as well when we finance our clients. There's a mutual benefit in that. So this is the strategy that we will continue to nurture and build up, and I'm sure the other banks will end up following suit. But at the moment, the space is very much dominated by us and then maybe the smaller banks.Now where do we want to grow? I would argue that demographics in Iceland and sort of our kind of natural resources and thriving kind of fourth pillar economy, which is the knowledge industry, definitely offers a growth potential. And so Iceland is our primary market. We've been -- yes. But if we sort of -- so Iceland has been our home market. I would say that sort of neighboring countries, Faroe Islands and Greenland are maybe the most natural places to look at. This is not something that we've embedded into our strategy yet, but could offer opportunities.But for external growth, I think this is something that we communicated in our last presentation. Asset management is clearly of an interest. Insurance business as well, maybe a bit of a constraint on -- because of competition act there. But we still -- we own the smallest insurance company in Iceland, so it should enable us to do some kind of external growth. So these would be, yes, less capital-intensive businesses that fit well with our strategy.You asked about, yes, the interest rate environment and rate cuts and it's -- obviously, if you look at our deposit base, it is very much priced at around 0, close to 0%, whereas the policy rate is at 75 basis points. So if CPI or Central Bank decides to reduce its policy rate, it will impact our NIM or net interest income.But if you look at the last kind of monetary policy announcement and due to the inflation at 4.3% inflation, if I remember correctly, the real policy rates are quite low. And you couldn't really see a guidance for further reduction in the policy rate in that statement. But obviously, if things -- if the economy turns for the worse, then we run that risk. And if interest rates start to rise, then -- I mean, we have much higher proportion of our book now on variable rates. So it will definitely follow or track that quite well, both on the asset and liability side.So it's -- yes, we're -- it's been a long session. And if there aren't any further questions, really thank you...

[Operator]

Apologies. There appears to be more questions registered. Our next question comes from Johan Ström from Carnegie.

[Johan Ström, Analyst of Financials]

A few questions from my side as well. I know it's dragging out on time, but it's a really good result. I think it's actually one of the best return on equity levels from Nordic banks in Q4. So I wanted to follow up on a few questions that, I think, already have been asked. You have this ISK 40 billion or so of excess capital on top of the capital reserve for 2021 dividend buybacks. And I appreciate the previous comments, but I still want to check whether you think it's likely to have a capital release of, let's say, more than ISK 20 billion, maybe even ISK 30 billion in 2022? Or will this take more time to get down closer to the 17% target CET1 ratio level? That's my first question.And then secondly, on the competitive environment, I also have a question there, but mine is more focused on the competitive situation towards pension funds in this low rate -- low interest rate environment. Has the competitive environment towards the pension funds improved? And then finally, a question for you, Benedikt. As you came in, you've done a lot of work. And I think maybe the hardest has been on the cost side. I think Arion is being operated at a much more efficient level now. But I have to say, the past 2 quarters, it's been quite difficult to kind of pin the trend on costs. So can you give any comments on what you think about the nominal cost for 2021? Maybe if not a number, just some more comments on the trajectory, please.

[Benedikt Gislason, Chief Executive Officer]

Thank you, Johan. On the capital release, I think it's sort of -- we say that we want to sort of follow the guidance by the regulator on dividend payments until -- in the autumn. And I guess this is structured in a way that by the autumn, we should know more about sort of the future prospects of the global economy as vaccination rates have gone higher and, hopefully, things have started to normalize. And I think to what degree and how quickly we can release this surplus capital very much ties with the economic situation, but also how our quarterly earnings leading up to the autumn or winter will evolve. So if we continue with a strong capital generation, then we have a much better comfort of sort of getting quicker to the 17% ratio, especially when we -- if we put it into a context that we still then have a meaningful management buffer on top of that. And currently, we don't see any kind of liquidity constraints for doing this. But -- and that's why we sort of -- we are conservatively guiding for ISK 50 billion of capital releases in the coming years or in the next years. But if we indeed continue on this path, then we will do -- be able to do it, hopefully, quicker than maybe investors will anticipate.Now the competitive environment is quite interesting here in Iceland. And out of a mortgage market that grew -- sort of the net mortgage balance in Iceland grew by some ISK 232 billion last year, and we had 68% of that [ through ] 30%. But we had actually a lower ratio if you look at the -- how much of the banks of their net mortgage portfolio changed. I think that was closer to ISK 300 billion. And that in itself reflects the fact that the pension funds have been unwilling or unable to move their mortgage products to the new interest rate levels. They're subject to a requirement, where the net present value of their liabilities -- or their assets actually 3.5% CPI linked, and that is putting a little bit of a constraint on them in participating in this new interest rate environment. And that's why the mortgage market has been dominated by the banks, and we are now seeing kind of a development that you see in the other Nordic countries, where majority of the mortgages are variable, non-CPI linked, and that's something that we'll probably see happening, getting to the similar levels as in Norway, for example, where I think it's 90%, let's say, in the next 2 to 3 years.And on the corporate side, we embraced their kind of entry there because of our strategy and really want to see them participate more. They are -- they have their biggest balance sheet. They have the ability to render credit to a size that the banks are sometimes unable to do due to regulatory requirements. So they are quite important when it comes to funding businesses here and the economy as a whole.And so we can say it out loudly, current interest rate levels with real policy rates at negative, massively negative levels has improved the competitive landscape of banks, especially because the pension funds are subject to kind of CPI calculations in their -- when they do their net asset value calculations.On the costs, I want to sort of dodge that question a bit and not go further than the sort of guide for the cost-to-income ratio of 45%. I just want to say that we have a strong cost control kind of discipline in place. And we have internal targets that are intended to bring this ratio down to the 45% level, even if revenues do not increase that much.And these are -- I mean we've reduced the square meters in our network or in our office space by more than 40% now, closer to 45%, probably in the last 3, 3.5 years. And FTE numbers continue to come down on the back of our services being digitized. So -- but the biggest cost item is IT, for sure. And there, we are putting sort of special focus on the infrastructure and developing a full-blown proper open banking platform, where we can then easily sort of open up to partnerships with other vendors or software providers to further sort of increase the service offering of the bank.And I think we've done much of the software development already that needed to be done internally. And I think, in the future, we'll see software development when it comes to digitizing services happening to a greater extent outside the bank. And we have already formed alliances where we're focusing on that. We are now a majority owner of a company that is dominant in the house rental market, where the development is taking place within that company. And we are providing the bank guarantee services and are connecting it to our platform.

[Operator]

Our next question comes from [indiscernible] from [ Landsbankinn ].

[Unknown Analyst]

I'm [indiscernible] here from [ Landsbankinn ]. I just have a very, very quick one question. I guess we're running out of time. Can you elaborate a little bit on the change of the treatment of Vördur and whether there was any kind of capital release there when the change was made?And maybe just the second question more on the buyback. This is my understanding that the FSA approval is based on the AT1 issuance, and that's kind of the rationale for the approval and not maybe on any retained earnings, dividends or buybacks.

[Benedikt Gislason, Chief Executive Officer]

Okay. Thank you for a good question. Now on Vördur, we are changing the treatment of Vördur. We basically, instead of consolidating it, we are adding the shareholding in Vördur through -- to our risk-weighted assets. And by doing this exercise, we are releasing around between ISK 3 billion and ISK 4 billion of capital.The authorization from the FSA on buybacks is not a function of the AT1 issuance. Obviously, the FSA is looking at the AT1 issuance and the fact that we had teed up for distribution when COVID hit. But the FSA is looking at the own capital structure and the financial strength of the bank when approving the buyback that we are obviously very pleased with.And I mean the normal procedure when we -- when the bank applies for a permission to buy back shares is that the regulator has a look at the business plan and stress tests -- does sort of stress testing of it. That's the main premise for giving an exemption like this. And obviously, the additional Tier 1 is helping because it's a capital instrument and enables us to grow with a stronger capital position through a stress test like that.

[Operator]

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

[Benedikt Gislason, Chief Executive Officer]

Okay. Thank you so much for watching and following the presentation, and thank you all for really good questions. And we look forward to presenting the first quarter results in April or May.

[Stefan Petursson, Chief Financial Officer]

May.

[Benedikt Gislason, Chief Executive Officer]

Early May. Yes. Thank you.

[Stefan Petursson, Chief Financial Officer]

Thank you.