Islandsbanki hf

ICEX:ISB

Earnings Call Transcript 2022-Q1

[Birna Einarsdottir, executive]

Good morning, and welcome to the webcast presentation, presentation of Islandsbanki first quarter result. I am Birna Einarsdottir and with me here today to present is Jon Guoni Omarsson, the CFO.

We published our result yesterday and the Board Meeting did approve the accounts. I'm looking forward to take you through the takeaways and highlights, and then Jon Guoni will tell you more about the details of the financials. In the end, we will have a Q&A session, and you can participate by using the dial-in details and the operator will give you the floor or you can submit questions through the webcast form.

Moving over to the highlights. We are very happy with the result. ISK 5.2 billion profit in the first quarter, 10.2% return on equity, which is in line with our target. So another very good quarter.

On the income side, we saw a strong growth, nearly 9% growth in income, on the income side. The main driver being the interest income that did increase over 12%. But we also saw a strong growth in many of the commission -- fee and commission factors such as asset management, investment banking and also in the card business that is recovering well after COVID. I was not going to mention COVID during this presentation, and I failed on the first slide, sorry.

The -- on the cost side, we are happy to see that we managed to reached our target to keep the cost flat -- the same cost as we saw last year. That is our target to reduce the cost by the inflation. But of course, we didn't expect inflation to be so high. So that is why I'm very happy that we managed to reach that target during the first quarter.

We had a positive impairment of ISK 0.5 billion. We mentioned in our last presentation that we still had ISK 3 billion that we had not released after -- the COVID impairment that we had not released. Now, we can say that we have around ISK 2 billion left. Of course, we will watch carefully how the tourist industry will be doing this summer before we release any further.

The capital position is strong and remains strong and we have around ISK 35 billion to ISK 40 billion excess capital, and Jon Guoni will take you through that in more details later.

The Icelandic economy is firmly on recovery path. And the financial position of both households and corporates are strong. The tourists are back, and we can say that Iceland is sold out this summer.

Our chief economist is forecasting 4.7% economic growth this year. And of course, the Ukraine war is increasing a short-term uncertainty, although direct impact is small due to limited trade relations. However, the inflation is rising and was measured 7.2% in April. And that is, of course, why the Central Bank did increase the interest rate last week, and we are now at a 3.75% level. And the Central Bank said in the presentation that we can expect a further increase in the interest rate later on this year.

On this slide, you can see an overview of how our business units were doing in the first quarter. The Personal Banking -- they were all doing very well. Personal Banking continue to see a growth in the loan book and during the quarter, we did launch a new sales -- digital sales platform, that will make it even easier for our clients to open new accounts. And we aim to see a digital sale going up to 90%. We are at the 75% level now, hopefully 90% next year.

The Business Banking had a record quarter with a very strong return on equity, and they have a very strong pipeline on the lending side. The Corporate Banking did also very -- & Investment Banking did also very well. We have the highest combined market share in our brokerage service. And we have many strong mandates in our corporate finance department. Iceland Funds continue to do well.

On the sustainability front, we did launch a new savings account, sustainable savings. We also did issue a EUR 300 billion sustainable bond and signed a loan agreement with NIB, green and SME lending. So -- just to -- before Jon Guoni will continue, on this slide, you can see that the share price of Islandsbanki has developed well since the listing last summer. And on the slide, you can also see the split between the shareholder groups.

During the quarter, the Icelandic government did continue the sales of its holdings in Islandsbanki and sold 22.5% and is now not longer a majority owner with 42.5%. The sales did cause a political and public debate in Iceland regarding the ABB sales method. The reason probably being that the ABB approach is not very well-known in Iceland. Islandsbanki corporate finance unit did act as adviser to the ISFI during the process.

Over to you, Jon Guoni, with more details on the financials.

[Jon Guoni Omarsson, executive]

Thank you very much, Birna, and good morning to you all. As Birna mentioned, we are very proud of the results for the first quarter.

Return on equity was slightly above our target and also above our guidance of 8% to 10%. The main reason being, obviously, positive impairments. You can see on this slide the change between years, where the biggest impact is the net interest income and obviously, the impairments as well.

Moving on to the next one. In terms of net interest income, we are seeing quite a bit of movement between products, you could say. Well, firstly, we see increased volume, both in lending and deposits. But the margins are changing quite a bit as the interest rate environment is changing. And now when rates are going up, we see an increase in deposit margins, but a decrease on the lending side.

On the bottom left, you can see the net interest margin. And there, we have seen now a bit of a pickup of 2.6% on the back of a higher rate environment. At the same time, however, we point out that we have now, at the end of the first quarter, we paid out the annual dividend of almost ISK 12 billion and are also planning for a ISK 15 billion buyback. And by distributing those funds, that obviously has a negative impact on net interest income and down NIM, but a positive impact on our profitability.

Net commission income, there we continue to see good growth between -- from between years. There's a bit of a drop between quarters, however, and that's due to seasonality mainly. So seasonality in cards and payment processing. And then also we had quite a bit of performance-related fees in asset management in the last quarter of last year. And that's -- that causes a bit of a drop between quarters. But like I said, a good increase year-on-year.

And we continue to see Icelanders traveling abroad to a more bigger degree, and that helps us in cards and payment processing. So we are quite hopeful for the second and the third quarter on that front.

In terms of net financial income, obviously, we have seen quite a bit of movement in the capital markets, especially on the bond side. And we had a bit of a drop in terms of our liquidity book where parts of the book is in the fixed income securities.

Offsetting that -- as you can see on the bottom left -- offsetting that partly is the mark-to-market for some of our derivatives. There we have had derivatives, for example, to hedge against the fixed rate mortgages and we have seen some gain on that front in the quarter.

You would -- maybe if you look at some of our competitors, some of them actually have these losses from their liquidity books going straight over equity, so not through the P&L. So I just wanted to point that out when you're comparing accounts between the different banks in Iceland.

But looking ahead, obviously, we now hope that there will be more stability in the -- on the fixed income side, especially, as rates have now come up quite substantially and are hopefully stabilizing at around this level.

In terms of the costs, as Birna said, we had basically flat costs year-on-year, which we are obviously very happy with and that gives us about 6.1% real reduction, obviously in a very high inflation environment.

FTEs continue to trend downwards and we are very focused -- continue to focus on basically increasing efficiencies in every unit of the bank and see -- still see quite a few opportunities ahead. And the cost-income ratio is in line with our guidance, which was between 45% and 50%, but slightly above our target of 45%.

In terms of the impairments, you can see here on the top left who those -- has been developing. There you can see the positive figures are obviously then charges, so basically the negative impact on the P&L. But negative figures are then -- is a release of impairments. And as you can see, in the past now 4 quarters, we have had a release of impairments. This quarter released ISK 800 million of impairments relating to the COVID era.

And as Birna mentioned, we noted in our Q4 results last year we had about ISK 3 billion of impairments from COVID, and that's now down to about ISK 2 billion. But offsetting that, we increased impairments about ISK 400 million due to the economic environment, which is very much related to, obviously, the conflict in Ukraine and the secondary effect that's having on inflation, especially. And some bit of an impact on investment levels, but mainly the impact on inflation. And so that's -- yes, so that's offsetting a bit the decrease in the impairment account that we're taking from COVID.

On the top right, you can see how the loan book has been developing. Nonperforming loans continue to trend downwards, now at 1.8%. And we are not seeing any companies, basically, coming into nonperformance, which is obviously very good to see.

The Stage 2 loans, now down to 7.1% and that's a trend that we hope to see continue in the coming few months. And as Birna mentioned, and we have talked about before, the outlook for the tourism industry is quite good for the summer. And we will hopefully see this trending downwards quite rapidly over the summer months as the companies pick up and the revenue increases in the summer.

In terms of the loan book, we saw a good growth -- 2% growth in the first quarter. It's a bit -- it's not very evenly distributed. We saw about 3% growth in both mortgages and also in SMEs. And we do expect to see now the mortgage growth slowing down a bit as rates have come up, obviously, quite steeply in the past few weeks with a 100-basis point rate hike earlier this week from the Central Bank.

The SMEs, however, we continue to see very strong interest there and now -- so basically investment levels picking up after COVID. And so hopefully, we'll continue to see good growth there.

On the Corporate & Investment Banking side, as we have mentioned before, we are not focusing on growing that book at the moment, but rather keeping it rather flat, even though it obviously can fluctuate between quarters, and then syndicating some of the loans.

And also, we have a so-called loan fund, which is run by Iceland Funds, our fund management company, where that fund has the opportunity to take part in some of the lending positions that we originate. And so that has been proving very successful as well. No major changes in the composition of the book. And the average LTV remains at a very moderate level.

We have a special slide here on mortgages, because we have, obviously, been seeing a very rapid development there over the past year or so. And actually, over the past 2 years, if you would look a bit further back. And there you can see the very strong increase on the top left. This results, obviously, in an increased market share, as you can see on the bottom left, where we have been picking up fairly steadily over the past couple of years, market share, as they had been very stable for the years before that.

The other banks are also picking up market share, as you can see. But the pension funds are losing a bit of a share and also the housing finance fund, which is in wind down process. This was just to show, especially maybe our international audience how the development has been over the past few years.

On the top right, you can see the -- in terms of the LTVs that remains still quite moderate at 65% on average. We note, however, that originated mortgages, which has been new originated within the past 18 months or so, there we have not taken in the increase in housing prices here into the LTV, because we measure the LTVs based on the purchase price for the first 18 months or so.

And therefore, we would say, because the real estate prices here, as elsewhere, have been rising quite rapidly by some 20%, that the actual LTV of the book, if you'd base on market prices, is quite a bit lower than 65%.

Finally, on the bottom left -- bottom right here, you can see the composition in terms of a mix between fixed, floating and the nominal rate and then CPI rate. And as you can see, the fixed, floating and in the nominal rates is a fairly good balance. And the fixed rate or fixed 3 to 5 years, CPI linked, this is a similar amount, but floating CPI much smaller.

The biggest increase in the past few months has been in fixed rate and in nominal. But now those rates have come up quite steadily. So we do expect to see the mix of new mortgages now moving into floating rate and nominal and maybe to inflation linked as well. But as we noted, the market has been extremely strong. We are starting now to see some signs that it might be slowing down, but we will obviously see how the year develops.

In terms of deposits, no major movements in there. A small decrease in some of the most stable deposits, but very limited movements from the end of the year. There was an increase in deposits relating to the government sell-down, which was at the end of March. And so those -- the deposits have now moved out of the bank, but otherwise, no major movements there.

Then on the borrowings, we issued a sustainable bond in January a EUR 300 million and therefore -- thereby, refinanced most of the maturities this year. As you can see on the middle graph here, we had ISK 15 billion at the end of March outstanding in foreign currency. That has now been repaid already in April. So we have now no outstanding maturities this year in foreign currency, but have the opportunity to prepay some of our outstanding bonds. We have some maturities in covered bonds and obviously, are actively issuing those here in Iceland.

I would like to note here that we have now our MREL requirement under BRRD I of 21%, but we are still awaiting exactly how the requirements will be under BRRD II. And depending on those, we will see how much of an opportunity we can have to issue covered bonds as well as part of our foreign currency funding. We have already updated our program, so we can issue -- call bonds in foreign currency. But like I said, both the quantum and the timing of that depends a bit on the MREL requirements that we will have.

In terms of the capital, you can see we have seen -- we saw a bit of a drop in the capital ratios in the first quarter. The biggest reason there was that we are now factoring in the ISK 15 billion buybacks that we are planning in the coming months. So that has been taken out of the capital ratios for prudency, obviously.

We have also seen a bit of an increase in risk exposure amounts. And that's due to various reasons we have -- we had some adjustments to our models, especially due to the SME factor and then also quite a bit of an increase, both in lending and loans to banks, which is a part of our cash reserves, which were at the quite high level at the end of March, and an increase in the derivatives as well. And so that explains the increase in REA.

As a result, we note now that our excess capital is around ISK 35 billion to ISK 40 billion, which we estimated at around ISK 40 billion at the end of last year.

And again, we plan to buy back shares in an amount of ISK 15 billion in the coming months and fully optimizing the capital structure over this year and the next. We note, however, here that due to the -- there has been quite a bit of scrutiny regarding the government recent sell-down of 22.5%. And as a result, there's may be a bit of uncertainty now in terms of our ability to buy back shares and the interest from shareholders to sell shares into a buyback. And that's something that we need to assess over the coming few weeks.

And also, we obviously highlight here, we have always the possibility of distributing capital through dividends to our shareholders. So we still retain those 2 options. But you could say that's a bit of a luxury problem in terms of how -- what is the optimum method to distribute capital.

Just to finalize the -- we were very happy with the results, and the outlook for the rest of the year is quite encouraging. The economy is picking up very well. And we note also in our accounts that due to a recent ruling, we are expecting a ISK 700 million upside through our impairment account. So overall, we are quite optimistic for the remainder of the year.

Over to you, Birna.

[Birna Einarsdottir, executive]

Yes. I think we just move over to the Q&A session now. And operator, are there any questions already on the line.

[Operator]

[Operator Instructions] We have a question from the line of Sofie Peterzens from JPMorgan.

[Sofie Peterzens, analyst]

Yes. Here is Sofie from JPMorgan. So I'm going to have 3 questions. So my first question would be kind of on the government selling down further. Has there been any indication from the Icelandic state when they potentially might consider kind of reducing their 42.5% stake further?

And then my second question is that I know that you say in your presentation that your rate sensitivity is quite insignificant. But it's -- kind of when we look back over the past year, your NII is up over 12%, were you seeing any margin pressure? And clearly, we have also seen much higher deposit margins. But kind of over the 12% year-on-year increase in NII, how much would you say is attributable to higher interest rates? So if rates had stayed where they were, have your NII have kind of performed if we look back?

And then my last question would be on the cost outlook. Inflation is higher in Iceland and also Europe. Could you just remind us how often do you kind of agree to the wages and when is your next wage kind of -- or whether are you discussing the wages next time? And how should we think about kind of wage inflation in '23 and '24 from higher wages potentially and also higher kind of IT spend? So that would be my question.

[Birna Einarsdottir, executive]

Thank you very much, Sofie. The first question, did I understand you right, you are -- if the government has said something about the further sale?

[Sofie Peterzens, analyst]

Yes. Exactly.

[Birna Einarsdottir, executive]

Now, as I mentioned, the process, the ABB process is being looked into or investigated, the whole process. And the government has said that nothing more will be sold until the outcome of this investigation. So I think we cannot expect anything until probably later this year, but not in the next few months I would say.

[Jon Guoni Omarsson, executive]

Yes, on the rate sensitivity, if I just maybe move back here to the slide on net interest income. So as you can see here, the change in lending margin and deposit margins, that's pretty much offsetting each other. So no major impact there, but slightly positive. Then we have the volume growth, obviously, both lending and deposits and then we have other interests.

And the biggest part of the other interest is due to the basically increased performance of the liquidity book. And there we are seeing the impact from the rate environment. I don't have the exact figure of what exactly, but I think that gives you a big -- the big picture of what is the sensitivities in terms of the rates.

[Birna Einarsdottir, executive]

Regarding the last question, the contracts that we have now -- the salary contracts are until the end of this year. And the next labor discussion will start this autumn. I think we will see some increase in wages, yes, we will see that. And of course, the unions, they have been criticizing the interest rate increase, and therefore, are claiming higher increase in the salaries. So we just need to wait and see how that will be developing.

[Operator]

And we have one more audio question from the line of Piers Brown from HSBC.

[Piers Brown, analyst]

Just a follow-up on the issue around the investigation and the government stake sales. I mean, should we be thinking that the exit of the government is now likely to take longer than before? I think they had an authorization to sell down till the end of 2023. So is that timeframe still realistic given this investigation?

And also, is the -- I mean you intimated that your buyback is slightly dependent on this investigation. So -- I mean if we're thinking the investigation doesn't complete until the back end of this year, does that also mean that the buyback is not going to start ahead of that? So if you could just clarify that, please.

And then the second question was on the COVID overlay, the ISK 2 billion of remaining COVID overlay. How should we think about possible further releases on that in coming quarters and how much may just simply be recycled into further macro overlays given the macro uncertainties?

[Jon Guoni Omarsson, executive]

So maybe if I -- on the -- in terms of the exit from the government in the national -- the government budget, they are expecting now additional sale this year of about ISK 25 billion and then the rest of the stake to be sold next year. So that's still in the government budget.

And obviously, with the government running -- has been running a deficit due to the COVID era, I think that it's still a part of their plans. But we will -- I think the timing, though, it's a bit more uncertainty there. And then we will see the results from the domestications, hopefully in the next month or so. And then we will be by a better position to assess what the next steps will be.

But like Birna said, we think it's -- hopefully, we expect to see a bit more of a sell down towards the end of this year and then continuing next year. But we will see in the next few weeks. In terms of the buybacks, we obviously see here now that in terms of our shareholder base that many of the shareholders have been rather than building up their share base rather than selling. And therefore, it's a question for us if we go out with, for example, an auction process in terms of buybacks and there are no sellers. That would be a bit problematic.

So we need to assess basically in the coming few weeks, firstly, whether obviously the government continues to be a seller and in what shape and form. And then also, whether other investors are keen on participating in such a buyback. The other -- we obviously have other options. The first one is to have a basically a buyback program where basically we have an independent broker here buying in the market. But that's something that we need to assess as well, and whether we can pick up sufficient volume through those kinds of measures.

And the third option then, if we see that it will be difficult for us to source paper, the third option is to simply pay out another dividend, later this year.

In terms of the COVID overlay of the remaining ISK 2 billion, it depends obviously on how the tourism does this summer. So if we have a very good performance and then the -- all the companies and our clients are in good shape, then we have the possibility to release those impairments over the course of the year. I do expect that we will be conservative in the second quarter because the strongest summer months for the customers are in July and August.

But then obviously, having seen then coming through the summer strongly, we have the opportunity to release this in especially the last 2 quarters of the year.

[Birna Einarsdottir, executive]

Did that answer your questions?

[Piers Brown, analyst]

Yes, that's very helpful. Could I just follow up on the ISK 700 million impairment release that you've mentioned. That seems a very big number for a single loan exposure. Can you give a little bit more detail on what that is? And I mean, should we just plug ISK 700 million in its entirety into our second quarter impairment forecast as released?

[Jon Guoni Omarsson, executive]

Yes. So this is actually a legal case that has been ongoing. It's from -- before 2008, and has been very -- going through the court over a very extended period. And so it's been marked at 0 in our books for quite a long time. So I can confirm that this is something that -- this is basically is a one-off upside of ISK 700 million.

[Birna Einarsdottir, executive]

In the next quarter.

[Piers Brown, analyst]

Okay. That's great.

[Birna Einarsdottir, executive]

Okay. Any further question?

[Operator]

We don't have any further questions at this point.

[Birna Einarsdottir, executive]

Any written questions? Okay. If not, then we say thank you very much for taking part in this webcast, and we are very happy with the results, as we mentioned before. So thank you very much.

[Jon Guoni Omarsson, executive]

Thank you.