Arion banki hf

ICEX:ARION

Earnings Call Transcript 2022-Q4

[Benedikt Gislason, executive]

Good morning, everyone, and a warm welcome to this presentation of Arion Banks Full Year and Q4 2022 Results. My name is Benedikt Gislason, I'm the CEO of Arion. And joining me here today for the presentation are our Chief Economist, Erna Bjorg Sverrisdottir; and our CFO, Olafur Hrafn Hoskuldsson.As always, I'll start by running through the main events for the year and then my colleagues will take over. It's fair to say that this was a challenging year when it came to financial markets, but despite that we had a really good performance. We saw our core income, which we define as interest and commission income and obviously, insurance income growing by 17.5% in the year. Our deposits grew by 15%, and the economy, obviously, on the back of an economy that probably grew somewhere between 6% and 7%. So, we ended up with a 13.7% ROE for the year, which is above our financial target. And as you can see in this slide, we have been revising some of these targets to reflect better on current economic situation and our business model as well.I mentioned the financial income, which is a volatile income line and will be a component of our business as we own and operate an insurance company with an investment portfolio. So we've changed 2 of our financial targets into core income-related targets rather than income, which we think will reflect better on our core operating performance. And you will see an extended version of this deck, which we published yesterday, which illustrates how these 2 new financial revised targets have retroactively kind of been. With other targets, they are either met or close to being met. And you see, for example, on the dividend payout ratio, that we effectively had more than 100% in the year as we released some of the surplus capital. And in the last 2 years, we've been able to release about ISK64 billion of capital through the means of dividends and buybacks, which is close to 30% of current market cap. And we foresee to continue to do so with the proposed 50% payout ratio of dividend, ISK8.5 per share, and then relaunching our buyback program this morning, and it obviously would depend on loan growth for the year and external growth to what extent we were able to continue to release surplus capital.I think it's an interesting fact that 5 years ago this bank had outstanding shares of 2 billion, and the current number is 1,510, and we will see our treasury shares being canceled after the AGM. So there's been a substantial reduction in our share capital or outstanding number of shares throughout the year and this will continue.I mentioned the loan growth target or loan growth. As you can see, we have removed that target. It doesn't mean that this is a complete U turn. I think the -- it's a bit harder to sort of predict economic situation for the year. Inflation is on the move, GDP forecast as well. And also I think it's important to flag that our origin to distribution strategy, which means that not everything that we do ends up on our balance sheet, is working very efficiently and we might expand on that operation this year.Now key milestones of the year, I think the sale of Valitor is obviously one of the key milestones and impacts our financial income. We're very pleased with the outcome and the sales proceeds, which amounted to $212.5 million, and is back -- is one of the reasons why we've been returning or returned so much capital throughout the last year. You might remember that Arion and Vorour joint operations with Vorour moving into headquarters. And so we together the 3 companies, which also include Stefnir, our front management business, can better leverage the different strengths and offer our customers a comprehensive and accessible range of financial and issuer services, and this is precisely one of the competitive advantages that we have here in the local market.Strong activity in corporate and investment banking and some progress with our real estate assets, which I will cover later on and some strides on the ESG front as well. Now, I mentioned that GDP growth has probably been between 6% and 7% for last year. We're waiting for the final numbers. And it clearly makes Iceland an outlier in a global macro context of last year and it backs the question, obviously, why was Iceland so resilient in these turbulent markets. And I think this slide here captures quite well why that was the reason, following the -- sort of in the aftermath of the financial crisis. Leverage was brought down considerably in the economy through means of restructuring and debt relief programs and more prudent finances of households and corporates, where we have seen very high savings rates for the past 8 years, at least. And so leverage is low, and leverage towards the rest of the world is actually extremely lower on the positive side. The reserves -- FX reserves are high and the net international position is positive. And I think it's actually a sign of strength that we've seen the Central Bank being able to raise the policy rates higher than in Europe. It's certainly not a sign of weakness.Now I mentioned the operation with -- or cooperation with Vordur, our subsidiary insurance business, which continues to grow. It delivered on its financial target of increasing its net premium by 3 percentage points more than the market and did so in the year. And here, you can see some of the financial targets that we internally look at every quarter. The bank insurance ratios, which are on the rise, and we have an ambition to grow this substantially further this year. And I don't need to remind investors that the insurance business is not only in Iceland, but in Northern Europe enjoy a healthy valuation on the back of good operating leverage and high profitability.Now I mentioned some strikes on the ESG front. And last year, we received a review from Sustainalytics, which placed us in the top 6th percentile of banks. And there we're looking -- comparing ourselves to the regional banks. And this has been a key focus for us and operating, obviously, in an economy which is mainly driven on renewable energy and we did an exercise as well with our credit portfolio, calculate the emissions and this is obviously to use as a comparison for next year, and we were aiming for improvements between years. And we've made considerable funding efforts and acquiring assets on the green asset and liability side.Now Arctic, the Arctic region is part of our business model and we saw a relatively strong growth in our credit portfolio in 2022, 62%, and the compounding annual growth rate since 2019 when we sort of started looking at it and then presented this as a key strategy in 2021 has been 48%. This is a very interesting sort of area, enjoys robust economic growth at the moment, rich of natural resources and is enjoying some of the main trends that the global economy is seeing like ecotourism.I mentioned the land development assets that Arion holds, which some are assets out of kind of -- or all of them are related to some kind of debt restructuring towards our clients. And this is obviously not a core asset for the bank, and we are deliberately now consolidating these assets under one umbrella, Lande [ Phonetic ] which is held directly on our balance sheet with employees of Arion working actively on this, both on operational side and with corporate presentation. I think the key milestones here will be the local planning process, which we will be continuing to work on this year and maybe a little bit into next year with relevant municipalities. And then it remains to be seen what we will do with it, whether we divest this in pieces or fully or if we distribute this through an extraordinary dividend to our shareholders. But this is -- the potential here for value creation is substantial.And with that, I'm going to hand over to my colleague and Chief Economist, Erna Bjorg Sverrisdottir.

[Erna Sverrisdóttir, executive]

Thank you, Benedikt. Good morning, everybody. I hope you had a pleasant winter so far. It's been a rapid breaking winter here in Iceland. December was the coldest December in over 50 years. And actually, in Reykjavik it was the coldest December in over 100 years. But thankfully, we rely on hydro on geothermal energy, which means that by a significant margin.While private consumption had the biggest impact, growth was mainly driven by exports, largely thanks to tourism. Although increasing economic activity has been reflected in strong imports growth, exports increased even more, leading to a positive contribution of foreign trade to GDP and a current account surplus for the first time since 2021. Nevertheless, it is a short respite as the current account deficit is the most likely result for a year as a whole. We're still waiting for the Q4 figures. And most analysts are expecting and forecasting a current account deficit for this year as well, even though tourism has regained its former strength, which it certainly has. In 2022, 1.7 million tourists visited Iceland, a 150% increase between years and 86% of the total number of 2019.In this context, we have to keep in mind that we began the year with COVID restrictions, both domestically and at the borders. But once the impact of the pandemic began to recede, we saw the tourist arrivals climb to 2019 levels fairly quickly. No less important is the fact that each tourist stay for a long period of time and spent more money than before the pandemic. According to the leading airlines flying to the country, the outlook is still bright despite the cost of living crisis raging on. With booking patterns, they have slowly begun to return to normal and bookings out of North America, especially strong. Still the uncertainties remain at large, as you can see, reflected in the wide range of the tourist arrival forecast, they range from 10% increase this year to 40% increase.According to Isavia, which handles operations and developments of the international airport, we can expect 2.2 million tourist to visit the country this year, which -- don't get me wrong, it will be a fantastic result, but I'm afraid it would create a challenging environment, both for the labor market and for tourism-related infrastructure. So, the Icelandic economy is still set for a pretty strong GDP growth, mainly export driven, with the consensus among domestic analysts at 2.1% GDP growth this year, followed by a 2.7% GDP growth next year. However, because census doesn't tell the whole story as currently analysts are very busy revising their forecast upwards due to preliminary figures on disposable income, which grew more strongly in the past 2 years than previously estimated. This means that the saving ratio has remained high and is well above its pre-pandemic average. So therefore, households, they can maintain a higher level of spending than previously anticipated.Furthermore, the conditions on the labor market have and will most likely continue to support private consumption. The labor market is very tight, unemployment is low, and significant labor shortage remains. More importantly, and in my opinion this is probably one of the biggest news of the quarter. New collective wage agreements were signed in December for a large part of the private market. The agreements are short term, they expire in January 2024, and they provide a generous wage increases.General wages increased by 6.75% and significant changes were made to wage tables and pay scales. So I think it's safe to assume that the nominal wage index will reflect a slightly higher relative change or closer to perhaps 8% increase on average in 2023. So while the new wage agreements certainly support private consumption, they are also inflationary, strong household demand, albeit slower growth than we've seen over the previous quarters just because we're coming from such a high levels will most likely be reflected in Icelanders trips abroad, imports, continued spending and thus putting continued pressure on the ISK.So the Monetary Policy Committee of the Central Bank certainly has its work cut out for it. The labor market remains tight. The wage growth is not consistent with inflation target. Households continue to spend like never before. The trade deficit has been growing. The ISK has been weakening quite sharply, especially in the fourth quarter of last year. Inflation expectations appear to be less firmly anchored and inflation is much more persistent than previously expected. Despite this obvious setback, it's not all doom and gloom for the central bank in its battle against inflation as the housing market, the main driver of inflation here in Iceland is rapidly cooling off. House prices in the capital area have fallen over the past 2 months, taking the 3-month change into negative territory for the first time since 2019. The year-over-year change is still positive, currently at 17%, but with less activity in the market, increased number of properties advertised for sale, rising interest rates and central bank's imposition of borrower-based measures, it is expected that the year-over-year change would fall quite rapidly even into negative territory.As our inflation composition differs significantly from Europe, we're not facing the same energy crisis or the cost of living prices. Our main hope of getting inflation down fairly quickly is by taming the housing market, which currently accounts for 40% of our inflation rate. And we are certainly on the right path in that sense, but still inflation is coming in hot, measuring 9.9% in January, which has compelled the Central Bank to continue to raise interest rates despite strongly indicating in October that the rate hike cycle was over. Since then, the Central Bank has raised rates by 75 basis points with the latest hike announced yesterday of 50 basis points.Now households have certainly felt the effects of rising interest rates. I think that -- because that service of non-indexed mortgages relative to wages, has been still all-time high. This has increased the popularity of inflation index mortgages, which in return reduces the effectiveness of the monetary policy. So, I guess you win some, you lose some. We still have very high inflation, imbalances in the housing market. We have strikes on the labor market, started last Tuesday and probably more to come next week, currently targeting certain hotel chains. And we have a way to expansion in fiscal policy. But still, Iceland is in a pretty enviable position with very strong foundations as Benedikt showed earlier. So hopefully, we'll continue to have more wins than losses in the future.That being said, I would like to welcome Olafur Hoskuldssonall, our CFO, to the stage, to go over the financials. Thank you.

[Olafur Hoskuldsson, executive]

Thank you, Erna, and good morning all. So I'll now look more closely at the numbers, starting as I usually do with my key highlights for the quarter. So a solid net profit in the quarter of ISK5 billion resulted in a very strong ISK25.4 billion profit for the year, representing an ROE of 13.4%. Again, a 13.7%. Again, pleasingly, the result is driven by continued momentum in our core income, which has increased by 18% over the year.Second, we see another quarterly growth in net interest income and the net interest margin for the quarter and for the year ends at 3.1%. As we have guided in recent quarters, we are starting to see rate sensitivities close somewhat as a result of funding cost on the wholesale side, increasing and increasing competition in deposits.Third, a very strong year in net fees and commission. The quarter ended at with ISK4 billion in fees, which ends the year at ISK16 billion, which is the highest on record for the Group.And fourth, our capital funding and liquidity position continue to be very robust. We continue to make progress on our capital optimization project and end the year with a common equity Tier 1 ratio of 18.8%, representing a buffer of 300 basis points above requirements. And this includes a dividend proposal of ISK12.5 billion and the ongoing buyback program, which we are launching the remaining ISK3 billion today. Again, we have a very strong liquidity position and a light maturity profile and have optionality when it comes to issuance plan over the near term.So looking more closely at the quarter. Operating income was ISK15.5 billion and a net profit of ISK5 billion in the period, resulting in an ROE of 10.7%. For the year, again, net earnings ISK25.4 billion and an ROE of 13.7%. I will discuss the key line items in more details on the following pages, but just highlighting a couple of points here.In terms of operating expenses, we are provisioning for a full payment related to the group incentive scheme in this quarter of ISK1.6 billion as the KPIs are expected to be met. As was the case last year, we are provisioning this in the fourth quarter as we now have sufficient visibility made on lease performance indicator. As we have discussed before, this variable incentive scheme is a key driver for the Group to manage fixed costs.Second, net impairments are positive by ISK400 million in the quarter. I'll discuss this in more detail on the following page, but this is primarily due to single name recoveries of previously written down exposures. We then have a ISK360 million negative impact from discontinuous operations in the quarter. This is partly a result of the revaluation of Stakksberg assets as we transfer them into subsidiary Lande. The remaining assets within the held-for-sale line now is effectively the holding of the bank in travel agency through Solbjarg, which is accounted for at 0. And going forward, we, therefore, expect very little activity in this held-for-sale line going forward.So looking at net interest income, which increased by 21% compared to the fourth quarter of last year and 1% between quarters. During the quarter, net interest-bearing assets increased by 4%, mainly through corporate loan growth at the end of the year. We also pre-financed both an upcoming Euro senior maturity and Tier 2 call dates later in the year. The result of that is that net interest margin is slightly down from the third quarter at 3.1%.We have added some more granularity under our disclosure on this page, especially around change in net interest income between quarters. As you can see here, there are 2 key items which are served to lower the net interest income between quarters. Firstly, we see cost of borrowing for wholesale funding rise by close to ISK900 billion between quarters. This follows, of course, the recent euro senior issue and the Tier 2 issuance, which for the first time in a relatively long time means that our funding cost is increasing.Secondly, received a ISK550 million impact from lower inflation in Q4 versus Q3. And while, of course, inflation remains elevated, the increase was greater in Q3 than Q4, and this means that there is a lower net interest income in the fourth quarter. We also show at the top right corner of this page a high-level view of how our key drivers of net interest income have been tracking. Here, the slight uptick in cost of borrowings can be seen and also that the cost of deposits have been increasing considerably over the past few quarters.In terms of guidance, we simply continue to highlight that this is a very dynamic market, especially in terms of cost of deposits, and it is difficult to provide a firm view of over the medium term. We do provide a sensitivity analysis in the notes of the account, but continue to view this as one scenario instead of guidance as such. But over the longer horizon, we would anticipate that the net interest margin would settle around the 3% area.So looking at fees and commissions. The ISK4 billion in the quarter concludes what has been a record year for the Group, with ISK16 billion in net fees and commissions over the year. This means that despite a challenging year in the insurance business, we again see net fees and insurance income covering 70% of our operating expenses, and this is up from 50% in 2018/'19. It is again very pleasing to see the value of the diversity in our fee-generating businesses with 5 key pillars contributing to this fee income for the year.The capital markets business finished a very strong year with a good quarter and ranked #1 both in equities and bond trading in Iceland. The combined ratio for the year ended up at 99% compared to 93% last year, and this is a result of claims increasing by 21% year-on-year. There are several factors contributing to this, which we've discussed in previous quarters. But the general view is that this is an unusual year, and there is optimism that this will turn around in the near term.This year, of course, the economy came out of COVID very fast, and there was a usual year as well in terms of weather in Iceland, which impacted a number of our insurance areas. As Benedikt mentioned, we continue to see momentum in the bancassurance strategy, and we are very optimistic around this business going forward.So, quickly on the financial income, which was broadly flat in the quarter. Included in the bond holdings loss in the quarter is ISK180 million loss on the housing financing front bonds, which we guided to in the Q3 presentation. During the past year, we have been actively managing down unlisted equity exposures, and these now stands at ISK6.7 billion versus ISK11.4 billion at the end of 2021. This is important, both in terms of managing Pillar 2 capital requirements and from an S&P RAC perspective.So we go to operating -- operating expenses. Again, the story is relative stability in the cost base despite inflationary pressures, a significant increase in operating income. This is reflected in the cost of core income of 45.6% compared to just under 52% last year and 62% in 2019. We also see this in terms of core income generated per employee, which is ISK78 million for the year versus ISK50 million in 2019. Another matter which we highlight on this page in terms of efficiency of the business is that total office base of the Group has decreased by 40% from 2020, with Vorour's move into our headquarters this year being the last in several matters over the past years in this regard. Total operating expenses for the year were ISK27 billion, and again, this includes the ISK1.6 billion provision for the employee incentive scheme, which is accounted for in Q4. Again, this is a variable scheme, which does not impact fixed costs into next year.So moving on to the balance sheet. So there are 3 highlights effectively that I want to highlight on this page. Firstly, as I mentioned, the sale of Valitor and the transfer of the assets of Stakksberg into Lante, the held for sale line in our balance sheet is effectively reduced to 0. This further simplifies our balance sheet going forward. This Stakksberg asset is now revalued as a development plot and is accounted for as investment property in other assets.Secondly, we continue to emphasize a focus of being competitive in terms of deposits. And while competition in this area is intensifying, we are growing deposits in the quarter by 2% and 15% over the year, and this has supported the 16% loan growth in the year. And finally, our liquidity and stable funding positions remain very robust with an LCR ratio of 158% and a net stable funding ratio of 119%.So in terms of loans, we continue to see growth in the loan book, which increased by ISK40 billion or 4% in the quarter and 16% over the year. This was primarily driven in this quarter by the corporate side, which had a very active end of the year and grew by 6% in the fourth quarter. The mortgage growth is slowing, however, as a result of the rising rates and growth in the retail side was under 2%. It should be noted that out of the ISK40 billion increase in the quarter, around ISK11 billion was the result of ISK depreciation, which impacts our FX loan portfolio and inflation impact on our CPI-linked loans.As Benedikt mentioned, we continue to see capital velocity as a key to our CIB strategy going forward. And during the year, we sold just under ISK22 billion of corporate loans to institutional investors. The loan book is very well balanced with 47% in mortgages, 6% other loans to individuals and 46% to corporates.So looking at our provisioning position. Total loss allowance at the end of the year stands at 0.6% of the loan book. This is slightly down from the third quarter mainly due to single name, recoveries of Stage 3 exposures. During the year, we have reflected worsening economic outlook in our IFRS 9 assumptions by increasing the likelihood of weight -- likelihood weight of pessimistic and base case scenarios and reducing the likelihood of optimistic scenario. We have also worsened somewhat a negative view within the pessimistic scenario. This tends to some extent been countered within the loss allowance from single name exposures, which have been recovered, and this is mostly from tourists in the tourist sector. We continue to see through the cycle expected loss on the loan book of 25 to 30 basis points based on the current loan book composition.So growth in deposits has been a key theme over the past couple of years, and this continued in 2022, with total deposits growing by ISK110 billion or 15% over the year. For the quarter, we continued to see growth in total deposits, which grew by just over 2%. In terms of core deposits, which we define as deposits from individuals, SMEs and corporates, we have also increased by 15% over the year, but three was a slight -- this was slightly down in the quarter. This is partly a seasonal trend as tax payments from corporates are due at the end of the year, which usually means a shift from corporate to the public sector at the end of the year.Deposits are now 60% of the bank's total liabilities, up from 50% in 2019. Loans to deposits have also continued to trend down and now stands at 144% versus 180% in 2018. Competition for deposits is strong and is increasing, and this is evident both in the retail and corporate side. We expect this to be a trend that continues into the coming year and will be a key determinant of lending growth in the year. We have, for example, seen significant volatility in deposits from some of our peers in the Nordics. And it is something that we expect to become more frequent over the coming years in the sector. We are in a very good position to compete in this market with our multiproduct long-term partnerships with most of our deposit clients and with a very efficient, agile and diversified business model.So moving on to wholesale funding. During the quarter, as I mentioned earlier, we successfully issued ISK12 billion in Tier 2 in ISK, but with both serves to optimize our capital position by filling our available Tier 2 capacity and also prefunding call date later in the year. It is pleasing and important that the market for capital instrument and senior funding in the domestic market seems to be increasing. This follows a successful senior euro issue that was completed in September and to gather these 2 issues prefund all our maturities and call dates in the year.In terms of euro spread development for the Icelandic banks, it is very positive that we are starting to see the reversal of the widening that continued for most of the second part of last year. Our fund depreciation allows us to be optimistic in terms of issuance plans in the coming year and in terms of pursuing profitable growth opportunities should they arise. We have euro senior maturities in May and December in 2024, which will be -- we will be considering during the issuing windows this year.So looking at our capital position. Our position remains very strong despite taking very large steps in capital optimizations over the past year. Following the upcoming dividend payment, we have paid over ISK80 billion to our shareholders since the beginning of 2021, or around 35% of the current market cap of the bank. And despite this, we end the quarter with a robust 18.8% common equity ratio, which is 300 basis points above requirements and above our 150 to 250 management buffer. This position, as mentioned, includes a foreseen dividend payment of ISK12.5 billion, corresponding to 50% dividend payout ratio and includes a full impact of the ongoing buyback program.The non-risk-based demature of capital, the leverage ratio, of course, continues to be very strong at 12%, which, as you all know, is probably double what you'll see of most of our peers in Europe. Capital optimization remains a focus for the Group. Our current 18.8% common equity ratio indicates around ISK9 billion in surplus capital above our midpoint target buffer. However, while we are not fully utilizing our AT1 capacity, we are required to use common equity capital to meet the Tier 1 capital requirements. This means that around ISK5.5 billion of common equity surplus is used to meet the Tier 1 target. We will be considering options for optimizing the AT1 loans over the near term, but clearly, this is market dependent. In terms of MREL, we currently have a 9.5% buffer above our 23% requirements as a percentage of risk exposure amount. This will be lowered by approximately 5% in May, when EUR300 million senior issue that is maturing in May 2024, which is within a year of maturity.So before I turn over to Q&A, I want to again highlight some of the key themes going forward. 2022 was a very strong year for the Group. We continue to simplify the business with a successful sale of Valitor and core operations have never been stronger. Our key strengths lie in the diversified pillars of the business, which all support each other through the cycle. The foundations of the business are also very strong. We have a robust balance sheet, a very strong capital and liquidity position and a funding position, which allows for flexibility in the coming months.The Icelandic economy is also in many ways in a relatively strong position as Benedikt and Erna highlighted earlier. We have a good opportunity in Iceland to manage a smooth stabilization of the economy in the coming years. The sharp change in rate environment will, however, continue to add volatility into this year, especially on our funding markets. We are in a very strong position to navigate this with, as mentioned, our light maturity profile on the wholesale side and a robust deposit base with long-standing multiproduct relationship clients. It is then very positive that spreads are starting to tighten in the euro market, which hopefully will continue in the near term.We continue to emphasize the importance of agility in the current environment. We are in a strong position with diverse profitable businesses and broad funding options. The current environment can bring growth opportunities as well as require changes to plans and therefore, agility is very important. Our updated medium-term targets reflect a positive view of retaining the current operational momentum while enhancing agility around growth and focusing, as Benedikt mentioned earlier, the effectiveness of our key KPIs.So on that note, I want to thank you, and now move over to Q&A, and welcome Theodor Fridbertsson to manage questions.

[Theodor Fridbertsson, executive]

Good morning all. Yes, my name is Theodor. We have already received a few questions online. So I think we'll start with that. And we have a few questions from Maria from Citi. And starting with deposits, Arion saw outflows of core deposits in Q4. How do you see deposit volumes this year? And what are the implications for your funding and margin outlook? So I guess, Olafur or Benedikt.

[Olafur Hoskuldsson, executive]

Yes, I think, maybe I'll start. I think I touched on it. I think -- first of all, I think we shouldn't be reading too much into the drop in core deposits in this quarter. We usually see a shift between corporate and the public sector in Q4. So this is more of a seasonal fluctuation. I think on the other hand, of course, the deposit growth for banks in general over the past few years has been extreme. And I don't think we should be expecting growth like this going forward. And the uncertainty around the growth is increasing. And as I mentioned before, I think the competition, the rate increases and competition also means that there could be shifts. So I think it's important that we don't sort of overly dramatize -- should there be quarters that we -- the deposits come down, and especially because if they are coming down, it is probably because we deem they're not being profitable business.So especially on the corporate side we see a lot of more shopping around. And so -- and those are more likely, of course. So we would expect more fluctuations there. I think in general, like I said as well, our deposit base is very strong. We have sort of multiproduct relationship with most of our clients. So this is not -- these are clients that have lost any relationship with us. So I think our deposit base is sticky, which is -- you can see over the past few quarters. In terms of impact on margin and...

[Benedikt Gislason, executive]

Yes. Maybe we should reflect a little bit on the most recent policy rate hike as well, the 50 basis points. and the potential impact of that for Linden and kind of the competition in the deposit market. I think this is -- the competition is quite heavy there. And generally, when rate -- when published rates are hiked, it positively impacts the NIM, at least short term. And I guess this is -- this makes us confident that we might remain for longer in the higher end of the range that we've been guiding for consistently over the past 2 years, 2.9% to 3.2% NIM.

[Olafur Hoskuldsson, executive]

And we have a sensitivity around the rate increase. So we are -- in notes, I think we were saying that 100 basis points increase roughly. It's a scenario. It's based on a number of assumptions. We are -- I think that reflects a ISK2 billion increase in net interest income. So that's there. That's one scenario. That's what we're looking at currently, but this changes quickly. And especially on the deposit side that can have a big impact.

[Theodor Fridbertsson, executive]

All right. Thank you. I mean, you spoke a little bit about the recent interest rate hike. So maybe, Erna, we also have a question about what will be the sort of the effects of that? Maybe your color on the economy.

[Erna Sverrisdóttir, executive]

In terms of the economy, well, we, of course -- I mean, this has been significant rate hikes over the past 2 years, but we must not forget where we are coming from. I mean, the rates and the Central Bank's key interest rates are still at similar levels they were 5 or 6 years ago. Of course, the aim is to tap in house of spending and the Central Bank, this is a preventionary measure that they're doing this because we have this new wage agreements that are very inflationary according to the estimations of the Central Bank. So that is the main goal to try to have hamper inflation and domestic demand. But still we see that the -- we come from such a strong position, especially if we look at households. Households have a very significant savings following the COVID crisis. The saving ratio remains very high. So households have a significant buffer to take on these rate hikes in my opinion.

[Theodor Fridbertsson, executive]

Then the third question, loans grew 4% for fourth quarter, how do you see credit demand evolving this year? And why did you remove the loan growth target now?

[Benedikt Gislason, executive]

As we said earlier in our presentation, the -- it's not a U turn. It's -- I think it's -- as I said, a combination of 2 things. There are probably greater uncertainty about these 2 key kind of economic numbers, GDP growth and inflation. And last year we saw both numbers quite high and normal growth was extremely high, and we saw that being reflected in our loan growth in the year. We are -- for this year, I think we -- the GDP growth would definitely be much lower. The uncertainty is is also about inflation and how persistent it will be. But at the same time, we want to focus more on this business angle that we adopted 3 years ago, which is to syndicate and sell off exposures. And we see that market just continuing to grow as the, for example, the insurance system has outgrown the banking system by a decent size already and their growth rate is higher than ours. So that's the primary reason.We see -- you will see it in the accounts that obviously, we have capital tied up against future commitments on kind of credit undertakings or commitments that we've already given out. And from that figure, you can see that the activity is quite robust still. And the economy certainly looks like it's continuing to grow based on that activity and corporate investment -- sort of capital investment seems to be higher on a number of high-profile projects as well, being openly discussed in various industries. So, its going to be a active year.

[Theodor Fridbertsson, executive]

What is the normalized level of net financial income, taking into account reduced bond and equity holdings and current level of interest rates?

[Olafur Hoskuldsson, executive]

I mean, sort of looking into a crystal ball what the financial markets will do next year. But I think in terms of us reducing equity holdings, this was mostly unlisted equity holdings. The portfolio was, of course, still growing, and that hasn't been reduced. So I don't think there's going to be a big shift on the outlook of the portfolio as such.

[Benedikt Gislason, executive]

I guess, the normalized level on the low side would be probably around ISK700 million. That's probably the guidance.

[Olafur Hoskuldsson, executive]

Yes, I think we've been guiding ISK800 [ Phonetic ] to ISK1 billion per quarter through the cycle. Obviously, that has reduced somewhat in line with this.

[Theodor Fridbertsson, executive]

So what cost growth do you expect this year considering the wage negotiations and still high inflation?

[Olafur Hoskuldsson, executive]

I mean we -- the union for bank employees has agreed, and we know that the impact of that agreement is about ISK60 million in salaries amount. And there's also a backdated because the contract was backdated by about 3 months. So there's going to be a ISK180 million one-off charge in Q1. So that's what we know about our own employees' impact. But then, of course, the general inflationary impact, it's more difficult to guide on that, but our aim is to try to manage cost as flat as we can.

[Benedikt Gislason, executive]

Yes. And as Olafur pointed out, the variable remuneration scheme that we have in place has indeed proved itself when it comes to kind of rates, additional rate inflation.

[Theodor Fridbertsson, executive]

Then we have a question from Tore, who is referring to the slide about the bank's development assets and Lante.When and how are these projects projected to show increased value in the financial statements of Arion Bank, as these projects have not been meaningfully marked up. What amounts will be released from these projects and when?

[Benedikt Gislason, executive]

Yes. As I mentioned in my presentation, we are currently doing extensive work on the planning side in close cooperation with the municipalities. These projects or 2 of them are -- 2 of the largest kind of residential real estate development projects in the capital area. And as such, kind of high on the agenda when it comes to delivering more supply into the real estate market, which is needed. There's been a shortage of housing for years now. And I'm sure -- I mean, our revaluation will be based on the progress there, both for the, what you call, I think, general planning and then local planning or district planning. And as we make progress, we will have to reevaluate this. And our intention is not to be the developer. We see sort of when the land has been sort of -- or building permits have been licensed that we will be selling off to real estate developers.

[Theodor Fridbertsson, executive]

And then we have a question from Stefan about Vorour. Vorour has continuously been increasing fees and the performance looks strong even in difficult bond and equity markets. The company's overall performance has been very strong. Is it your opinion that the value of Vorour is adequately represented in the market cap of Arion Bank in light of the market value of the stand-alone insurance companies on Nasdaq Iceland?

[Benedikt Gislason, executive]

I think in the long run, investors will value the diversification in our revenue streams, including kind of insurance business and we might on the back of that enjoy kind of premium valuation to other comparable financial institutions that don't have the same diversification. Whether that's the case now, it's I think up for others to judge, but we are at least very happy with the trajectory of the buildup of Vorour, and we certainly believe that this is of great value creation for our shareholders.

[Theodor Fridbertsson, executive]

Then we have 2 questions from [ Indiscernible ] How much capital can Lante developments generate?

[Benedikt Gislason, executive]

We have been a little bit hesitant to sort of give guidance on that. But the reference points are that -- and this is public information, that the units -- the building units there on the residential real estate side are probably in excess of 4,000. And there's a price reference price for that, assuming 100 square meters average flat and a range of, I guess, ISK70,000 to ISK120,000 per square meter for land fully developed. So that would be the reference points, but I'll leave it up to the experts to calculate this further.

[Theodor Fridbertsson, executive]

And the second question from [ Indiscernible ] is are you worried about the PTI levels that the current mortgage rates imply for floating rate borrowers in '24 and '25?.

[Benedikt Gislason, executive]

Do you want to comment?

[Olafur Hoskuldsson, executive]

I mean, worried. I mean no, but clearly, the rate increases are going to be having an impact on these clients. There's been a significant increase in payments for those that are on floating rates. But of course, we have the other products of the CPI-linked mortgages, which we expect. And I think it's fair to expect that it will become more partner and is a way for these clients to at least manage the cost out.

[Benedikt Gislason, executive]

And I think it's important to note that the cost of refinancing and the time it takes is low and short. It's a very efficient mortgage market. I think we've developed one of the more efficient mortgage markets in Europe, with a great degree of flexibility for borrowers. And so their ability to navigate their mostly payments and which can sometimes impact the kind of the equity creation within -- for a homeowner. So moving from non-CPIs to CPI, maybe slows the equity creation as a homeowner, but it certainly can change the monthly payments substantially. And we're seeing that. We're seeing that pattern already. And also, I think it's important to flag that the reason why the Central Bank has been raising rates is that private consumption is still on the rise, and that's on the back of net personal income still being on the rise. So affordability is...

[Erna Sverrisdóttir, executive]

Add to that. If you look at -- because we're just talking about the bank here, but if you look at the economy as a whole, the Central Bank has done stress testing on the household sector, what will happen in '24, '25, when the rate change hits the most households and according to their estimates, they are not overly worried of the effects it will have on households. Of course, we have always these options as both Benedikt and Olafur have mentioned is going to the CPI-linked mortgages. But overall, it looks like households are very capable of dealing with this, at least the sector as a whole.

[Benedikt Gislason, executive]

And going into this rate hike cycle with a low kind of leverage from a historical standpoint and an international standpoint as well.

[Theodor Fridbertsson, executive]

All right. Then we have a question from Lilliana from Goldman Sachs. Good morning. Congratulations on the results. One question. Would you look to continue reduction of unlisted equity holdings to help your P2R? Or are there any other message you could implement to reduce it from fairly high levels currently?

[Benedikt Gislason, executive]

So a very good question. And it comes into a key focus that I think we've discussed in previous earnings calls that we want to see our Pillar 2 requirement come down, and that's why we've been managing some of the exposures at TI Capital in the Pillar 2 concentration risk, interest rate risk and equity risk and we're optimistic that our plan for the next 2 to 3 years will result in lower requirements. There are a number of lag kind of assets that have historical reference, or ownership in Valitor resulted in ownership in Visa shares of different share classes, as most financial companies in Europe that had exposure to the payment sector and the top owing. It's very good to see that the conversion between the C and A class has been very kind of robust throughout the years, and we're seeing this exposure coming down gradually. This has been tying up capital. And -- but, I mean our investment portfolio will always be part of our business. But as you see from the fourth quarter numbers, we've taken down the exposure in this quarter.

[Olafur Hoskuldsson, executive]

Yes. I mean, I think we might have some more assets that we're looking to divest, but I think this will be -- this will still be -- and like Benedikt said, it is a part of our business to have the option of investing along with our clients. So we want -- we would probably have some unlisted holdings on our book, but I think the plan is for this to be more high velocity of these assets as well, and so manage them more frequently in and out. But I think we will not be probably increasing from this level, at least, hopefully, reducing somewhat.

[Theodor Fridbertsson, executive]

All right. This concludes sort of a good list of questions from people participating virtually. So I guess I'll move on to the auditorium. Are there any questions? -- final questions?. No, and I guess we'll conclude this meeting. And thank you all for participating. See you next time.