Islandsbanki hf

ICEX:ISB

Earnings Call Transcript 2023-Q1

[Birna Einarsdottir, executive]

Good morning, and welcome to Íslandsbanki. Today, we are presenting the financial results for the first quarter of 2023. I am Birna Einarsdottir. I'm the CEO of Íslandsbanki, and with me here today is Jón Ómarsson, like before, our CFO. Thank you all very much for taking the time to join us this morning. We know this is a busy time for both analysts and investors.

We are happy with the outcome of the first quarter, and I'm looking forward to take you through the highlights. And then Jón Gudni, like before, will take you through the details of the financials. Following the presentation, we will have a Q&A session. You can participate in the session via the conference call using the dial-in details and the operator will give you the floor or you can submit questions in writing using the webcast form.

But moving over to the highlights. We are presenting today strong and good financial results for the first quarter of 2023. The profit was ISK 6.2 billion, 11.4% return on equity in the quarter, which is above our target. We see -- we saw a strong year-on-year growth on the income side, especially on the interest income, almost 35%. And we also saw a strong growth on the fee and commission side.

The reason being larger balance sheet and, of course, a higher interest rate environment is also giving us more income, especially on the liquidity portfolio of the bank. The cost/income ratio for the quarter is 42%. And our guidance for 2023 is to have the cost/income ratio between 40% and 45%. So we are in that range.

But the first quarter was cost heavy. Inflation and general rates increases are having impact. And we also saw in the first quarter and here we -- some specific cost items that will -- that we are expecting to even out throughout the year. We will continue to be focused on the cost side like before.

Our deposit base is growing and is well diversified between business segments. And the net impairment for the first quarter is ISK [ 60 billion ] to ISK 75 billion, mainly due to growth on our loan portfolio and also for the updated economic forecast. The quality of the loan book remains strong, and our loan portfolio is very well collateralized.

Now briefly on our targets. We are pleased that we are on track with all our financial targets. But as you see from the slide, we have updated our Tier 1 target where we have previously been giving a certain percent but will now and onward display the Tier 1 target as a specific buffer above the regulatory requirement.

Our optimal operational capital buffer remains around 200 basis points, above the regulatory requirement. We have seen changes in the requirement for the last couple of years due to various reasons, including Pillar 2 requirement and regulatory capital buffers.

But quickly now on the Icelandic economy. The outcome is -- that we will see a slower growth in year '23 than in '22 and the -- our Chief Economist is forecasting 3.4% growth. The main driver being the export industry, tourism being the biggest player there, and we are expecting a moderate year-on-year growth on the domestic demand.

The housing market is normalizing following a period of rapid price increases. And the outlook is for stable real house prices throughout this year. Inflation has spiked recently in Iceland like in other countries. After peaking in February in 10.2%, we saw inflation in April going down to 9.9%.

It is relatively broad-based. The reason for the inflation increases in the domestic cost pressure and also global cost pressure and housing cost is, though, less in the latest update. Of course, the Central Bank has reacted to the inflation like in other countries.

In this slide, we are giving an overview of our business units, the performance in the first quarter. All the business units did perform well. personal banking had a good quarter. Both -- we saw growth on the lending portfolio and deposit year-on-year. And also, I'm going to tell you more on the next slide about the development -- on the digital development.

And we saw also a strong return on equity on -- in the business banking and also strong growth -- we published in the quarter report on the SME and how important the SME is to the Icelandic economy, very interesting report. And we continue to have a strong market share in that sector.

Corporate and investment banking had a good quarter. Our derivative desk and the FX sale were strong, and we also saw new lending in the first quarter. And asset under management with the Ísland funds were nearly ISK 400 billion. And Allianz Ísland has been doing very well in the first quarter.

Briefly on our digital sales -- digital service. As we have often mentioned before, we have seen for a few years now, that all our transactions, 99% of all our transactions are done on the line. And -- but our target has been mainly for the last few years to increase the sales or the account opening online. And that is something that we saw coming in very strong in the first quarter.

And for example, we started with a new online savings accounts that we have seen a very strong uptake and especially in the first quarter of this year. So the -- of course, when you are focusing on online, you need to ensure that your design on the website and -- is attractive. And that is why we were very happy to be awarded with the corporate website of the year in the category for large corporates.

In the first quarter of this year, we updated our strategy, and that was approved by the Board in March and was presented to all staff. The strategy was formed very much in cooperation with all employees across the bank and also with the advice from McKinsey. The role of Íslandsbanki will continue to be forced for good. And the corporate vision is to create a value for the future.

And we have also defined our strategy priorities for the year '23 to '25, which are: service, data, sustainability and employees. Those are the priorities that we will focus on for the next 4 -- next 2 years. But at the same time, we are also looking into growth opportunities, both organic growth and opportunity outside the bank. That is why the ongoing discussion with Kvika bank are in our opinion and natural step in that journey. The project is a large in scale and advisers on both parties are currently assessing the synergies that could be gained from the merge and also assessing the position of the company in the market.

We have a dedicated group inside the bank that are focusing on this project. But of course, we are continuing our focus on our clients and working with them on interesting projects. Now over to you, Jón Gudni.

[Jon Guoni Omarsson, executive]

You, Birna. Starting with the slide showing the bridge between the 2 years. We can see that this is obviously a bit of a mirror of the turbulent environment, where we are seeing high inflation and high interest rates at the same time. And this obviously comes into play with net interest income growing substantially between years and also a good overall increase in the income base. But at the same time, an increase in the cost base as well, and both -- so both on the operational expenses and also in the net impairment account.

If we look at the net interest income, we see our margin moving upward slightly to 3.2%. And on the right side, you can see the factors impacting this. Of the overall is about ISK 3.2 billion increase between years in the net interest income. You can see the maturity of that ISK 1.9 billion is due to basically other interests, which is mainly our liquidity book.

The rest is mainly from the growth in lending in both deposits and -- sorry, growth in both lending and deposits. So only a small part of the increase is from increased margins. In terms of the net fee and commission income, we saw very good growth in cards and payments. You could say this is the last quarter where we are seeing this deep growth coming as we're coming out of COVID.

And at the same time, we had a very good increase in other fees and commissions, which is mainly our subsidiary, Allianz Ísland, which sells Allianz products here domestically, and had a very good first quarter of the year. Asset Management is slightly down, and that was mainly due to a bit of a decrease in assets under management last year due to obviously weak capital markets during the course of 2022.

Investment banking is obviously volatile, so that moves between quarters, but slightly down year-on-year. In terms of net financial income, we obviously see here the volatility in the yield curves and especially the domestic market where we have a negative impact in our liquidity book from mark-to-market. And a point to take here that our liquidity book is fully mark-to-market.

And then we have also economic hedges, as you can see at the bottom left here, and so these are derivative contracts to hedge against the fixed rate risk. And as you can see, we are well protected on that side. And therefore, the net impact is positive ISK 500 million in the quarter. We continue to reduce a bit our exposure to equities, as you can see at the top right, and basically manage our market risk within very tight limits.

In terms of the costs, as Birna mentioned, the first quarter was quite cost heavy. There are a few different reasons. The biggest reason is the general wage agreements that were reached early this year, actually, and that has an impact on the overall salary levels for all domestic companies.

And as you can see on the bottom right here, that's the first bit there. Then we had also various other cost items. And the ones in yellow here are the items that will largely even out throughout the year or are basically met with higher income, so a part of the increase. So we don't expect to see this high percent increase between years for the year as a whole. But saw the first quarter as being cost heavy. And like I said, quite a big part of it will even out throughout the year.

And as a result, and as Birna mentioned, we are still expecting the cost/income ratio to be between 40% and 45% for the year as a whole and 42.1% for the first quarter. In terms of the loan book, you can see on the top left that we saw fairly decent growth in the first quarter, 2.8%. And that was across the board from all business units.

We are seeing now things slowing down a bit. Interest rates obviously are now at quite a high level. So for example, in SMEs, you can see -- for new projects that the customers are seeing with the interest of between -- well, 9% to 12%, depending on the different credits, and that obviously impact the investment decisions. So we expect to see a bit of a slowing down and the interest rate hikes from the Central Bank will start to work in that regard.

In terms of the LTVs, no major changes there, and we -- our portfolio remains very healthy and well collateralized. In terms of the asset quality, on the top left, you can see here, we have -- we had impairment charge of about 22 basis points cost of risk in the quarter. It was mainly -- was a couple of specific cases. And then an update to our scenarios, the economic scenarios, especially factoring in a bit higher inflation expectations. And at the same time, obviously, seeing a growth in the loan book, which adds to the impairment account.

On the top right, you can see that we -- there was a bit of a small increase in the Stage 2 loans. That's due to a couple of specific cases. So it's not a broad trend that we're seeing, but rather just a couple of cases. And those have partly actually returned now to more normal in the second quarter.

So we're not seeing -- like I said, we're not seeing this as a general broad trend. And Stage 3 loans remained at a very low level at 1.7%. In terms of specific portfolios, the mortgage book remains very healthy in terms of credit quality. As you can see on the bottom right here, no changes there basically.

We still see very low unemployment in Iceland. Some of our customers are moving partly into inflation-linked products to relieve a bit of their monthly payment, but no increase in delinquencies and quite a healthy book.

In commercial real estate, that obviously has been quite debated and discussed in various countries. In Iceland, that market is quite stable. The biggest commercial entities -- commercial real estate companies in Iceland are listed and have been doing quite well. There's a fairly good balance between demand and supply on that front.

And we are seeing also that these companies, in general, are well funded and for the longer time. We also know that quite a few of these customers have hedges basically. So they have some of their rent agreements in inflation-linked and thereby hedging against some inflation-linked debt on the liability side.

We are seeing -- so a bit of an increase in Stage 2 loans in the first quarter. And that's like I mentioned before, a couple of specific cases, but some of those have recovered already in the second quarter. So we're not seeing this as a broader trend, like I mentioned before.

In terms of the funding side, we saw a bit of an increase in deposits in the first quarter and overall, a very stable deposit base. The increase came from individuals, retail deposits, so the most stable part, which we're obviously very happy to see growing, but all the deposits being quite stable.

On the funding front, we continue to diversify our funding. So last year, we have -- we started to issue foreign currency covered bonds, and we have also been building up the domestic market, both in terms of senior unsecured and Tier 2 bonds. You can see in the middle here, we have a policy to have below 10% of our balance sheet maturing each year, and we are well below that, as you can see.

And we are planning -- this year, we plan to issue one senior unsecured benchmark issuance in the international market. And we continue to issue covered bonds here domestically on a very regular basis -- monthly basis. And then we plan to -- we have one Tier 2 bond in the late summer coming up for early prepayment. And we plan to replace that with a bond either in the domestic market or possibly the Scandinavian market, depending obviously on market circumstances.

In terms of liquidity, we remain very well liquid with the liquid assets close to ISK 300 billion and the LCR ratio of 171% at the end of the quarter. In terms of capital, as Birna mentioned before, we changed basically how we present our capital targets. We had a fixed number before. But as we have seen a fair bit of volatility in the capital requirements over the past couple of years, we decided to move to what is quite common with our Nordic peers to base the capital target on basically -- buffer on top of the regulatory requirements.

And we also increased a bit the size of the buffer in terms of the range -- the size of the range. So from 50 to 200 basis points to 100 to 300 and due to basically saying that we can see some volatility in the capital ratios. But our sweet spot, as you can see, the optimal operational capital buffer remains at around 200 basis points. So that has not changed.

Based on the current capital requirement, that means our optimal range is 16.3% and up to 18.3%, with the sweet spot in the middle at 17.3%. In terms of the requirements, we will see the countercyclical buffer rise by 50 basis points in the first quarter of next year. At the same time, however, we are hoping to see a bit of a reduction in the Pillar 2 charge.

The charge is now 2.6% but was 1.7% before COVID and rose mainly due to impact from COVID. And so we're hoping to see some of that coming back and hopefully -- at least partly offsetting the increase in the countercyclical buffer. And as you can see at the bottom right, our CET buffer is then at 460 basis points, above regulatory requirements, so a bit outside of our target range. And as before, we have noted that we plan to optimize our capital position and the capital combination before the end of next year.

Then just to conclude, we are very happy with the operational results in the first quarter, a very healthy return on equity, and we remain with a very strong balance sheet and capital ratios. So back over to you, Birna.

[Birna Einarsdottir, executive]

Yes. Okay. We're now open for Q&A. And as I mentioned before, you can participate in the session via the conference call or you can submit questions in writing. So operator, are there any questions?

[Operator]

[Operator Instructions] We will take our first question. The question comes from the line of Sofie Peterzens from JPMorgan.

[Sofie Peterzens, analyst]

Here is Sofie from JPMorgan. I was wondering, I know you said that you're assessing the synergies from the Kvika Banki merger and kind of market positioning. But is there anything you could kind of give in terms of numbers like, first, a potential merger? Like how should we think about your market shares in the different products? Will the competition authorities potentially have any issues with this? Kind of -- what kind of synergies do you expect, even if you can't keep numbers, but kind of which products? What kind of growth synergies you would potentially have? I read out [indiscernible] you don't have many branches. So maybe not there, but you got a staff reduction or maybe there or no. But if you could maybe just give some thoughts around the potential synergies and kind of market positioning, what it could mean for Íslandsbanki.

And then my second question would be on net interest income outlook from here. NII growth seems to be slowing down and kind of, I guess, the rate cycle is coming down in. But how should we think about the NII outlook going forward? And how do you think about volume growth and which products and kind of margin development?

And then my final question would be on your capital position. It seems that the share buyback deduction is much lower, but could you just confirm what share buyback you now have deducted from your core equity Tier 1 and how we should think about future capital distribution to shareholders?

[Birna Einarsdottir, executive]

If I start with the first one, Sofie, thank you very much for those questions. There is very limited of what we can say about synergies and where we are exactly in the process. We have hired -- both parties have hired advisers that are working hard to calculate the possibly synergies. And of course, we are analyzing the market with our competition lawyers also because we know that the competition authorities work stream is a very important part of this work. So that is, of course, a heavy focus on that part. So there's very limited that I can say. But as I mentioned, in our strategy that was approved in March, we are interested in growth, both organic growth and external growth. And we were planning to look into insurance and also how we could grow in asset management.

And those 2 factors are something that [indiscernible] is -- they have an insurance that we don't have. And I have always been strong also on the asset management side. So that is why it was not a difficult decision to decide to enter into the discussions. So that is where we are. Of course, we hope that we will be able to tell more soon.

[Jon Guoni Omarsson, executive]

And on the other question, so first, regarding net interest income, we are still seeing some increases in the rate environment, and there are still expectations for rate increases here in Iceland. So that obviously continues to then impact our earnings from our liquidity book. So we still expect to see some increase in net interest income, but that will obviously then hopefully actually, you could say, go down next year when the interest rate environment totally normalizes as inflation comes down.

But through this year, I think we can expect quite strong performance on the net interest income item. Point to note, in terms of the margins, deposits and loans, we are seeing quite, I would say, high beta on that front. So basically, we have the last couple of rate increases from the Central Bank. We have moved that into both loan and deposit pricing to a large degree. So we don't expect a lot of pickup from there, but mainly coming from the liquidity book.

In terms of capital, we -- as we disclosed in our Q -- basically in the full year accounts for 2022, we reduced our plans then. We had plans for ISK 15 billion of buybacks, reduced that to ISK 5 billion due to the environment and all the factors. And so that's something that we have -- of the ISK 5 billion, we have already actually bought back close to ISK 1 billion. And the remainder is excluded from our CET1 ratio. And this is something that we are planning to continue now in the coming few months, obviously subject to market conditions. And like I said before, we plan to optimize the capital structure before the end of 2024.

[Operator]

Your next question comes from the line of Maria Semikhatova from Citi.

[Maria Semikhatova, analyst]

A couple from my side. First on NII. Thank you for your comment on liquidity and margins. Just wanted to check with you if you expect any outflows of deposits that could affect NII trajectory. Also on your cost growth, I understand there were some items that you hope won't be recurring in the following quarters. But how do you see cost growth for the full year. There's still target below inflation. And you mentioned strategic projects that are included in your bridge, how much of this investment do you have earmarked for this year? And is it just for 2023? Or this is kind of an ongoing investment for several years?

And finally, to clarify on method quality, you mentioned specific cases in CRE that affected Stage 2 loans, but also some specific cases that affected provisioning lines. Are those connected? And given that you saw some recoveries in the second quarter, would you unwind as well in the P&L from this -- from improvement in Stage 2?

And maybe more generally on CRE exposure. How concentrated is your book? If you could share, I know, for example, how much the 20 largest borrowers account for total exposure or, let's say, what is the exposure to the listed CRE firms wherever you can disclose?

[Birna Einarsdottir, executive]

Thank you, Maria. If I start with the deposit, yes, we are expecting the deposit to be stable. As we did show on our slide, it is very well diversified between individuals and corporates, and institutional investors. So yes, we are expecting actually, in our forecast, modest growth in our deposit for this year. On the cost side, we went through that in details earlier. Of course, we will see the cost because we have an inflation of nearly 10% in Iceland. And we have seen -- and both -- and also on the salary side, the rate agreements have -- will be at least 5% to 7% increase in salaries this year. So of course, we need to take this into account.

But this one-off that we saw in the first quarter. We are hoping to be able to even that out. We were -- as I mentioned also before, we were in middle of our strategy work during the first quarter that, of course, is always some investment that you -- that follows. But on the strategy side, I mentioned, for example, data being one of the big part of our strategy and service cost, there is nothing new. We are restructuring how we manage those important part of our operation. But we already have forecasted, for example, cost regarding data management and, of course, on the service management side. Jón Gudni, would you like to add something on the cost side?

[Jon Guoni Omarsson, executive]

No, I think you covered it quite well. And like [indiscernible], we haven't put out a forecast for the overall cost base for this year. But like Birna said, the inflation is running at around 10%. The general wage increases factoring cost increases of probably around 7% to 8% based on our employee base. So it's quite, quite steep increases, but at the same time, the additional cost that we had in Q1, and for example, strategic projects, that's not something we do every year. It's quite cost heavy. We're investing quite heavily in that at the moment. And so we don't expect that to continue throughout the year.

Also some renovations of our headquarters here, which are just only in the first quarter. In terms of the commercial real estate book, I don't have the exact numbers here. It's not very concentrated, but that's obviously something we can provide you in a bit more detail. But overall, it's a well-performing book.

That sector has been performing very well over the past few years, and our customers there are, in general, extremely healthy and profitable. And the couple of cases that I mentioned, like I said, partly have recovered again, whether we can see some reversal of impairments, possibly some small numbers. But like I said, the increase in impairments in the first quarter, the biggest increase there is due to basically growth in the book and the economic scenarios basically factoring a bit higher inflation. So that has no big numbers in terms of reversals due to these particular credits.

[Birna Einarsdottir, executive]

And we are expecting to be in more normalized impairment this year unlike the couple of years before.

[Jon Guoni Omarsson, executive]

Yes, I think we got it.

[Sofie Peterzens, analyst]

Just maybe a quick one follow-up on -- since you mentioned the Pillar 2 requirement is elevated because of the COVID. So what is the necessary trigger for this to be lower?

[Jon Guoni Omarsson, executive]

Yes. So like I said, we saw an increase from 1.7% before COVID to 2.6% now. And a big part of that is due to forbearance measures relating to COVID. And those have now come -- have been finalized, and so it takes 2 years to come out of forbearance, and that has been now materializing bit by bit and to a large degree already. So we are hoping to see a bit of a decrease there, but at the same time, it's a bit difficult because it's -- we can't obviously say what the regulator will do. But based on what we see and the risk profile due to this, we believe that we can expect a bit of a reduction in the Pillar 2 charge.

[Operator]

[Operator Instructions]

[Birna Einarsdottir, executive]

Are there any question in writing?

[Unknown Executive]

A question from [indiscernible]. Could you please remind us of your issuance plans for the year? Also, could you please elaborate on your plans to optimize the capital position.

[Jon Guoni Omarsson, executive]

Yes. So firstly, on the issuance plans. As I noted before, we plan to issue one benchmark issuance in the European market this year. possibly a company with smaller transactions in the Nordic market or other markets where we can have a smaller trades along with it. Domestically, we always issue monthly basically covered bonds, and they remain a steady issuer there. We have also been building up both the Tier 2 and the senior unsecured market here in Iceland. So I think we will look into that as well here domestically.

And like I said, we have one Tier 2 coming up for prepayment a bit later this year, and we will be looking at both the domestic market and especially the Nordic market in terms of that. In terms of the capital plans and like I noted before, we have plans for a ISK 5 billion buyback, which ISK 1 billion has been concluded already and the rest is planned over the coming few months, subject to market conditions, obviously, good to see the current turmoil coming down a bit. And then we still plan to fully optimize the capital structure before the end of next year. And that means, obviously, bringing our core Tier 1 ratio within the target range, and again, obviously, subject to market conditions and calmer markets.

[Birna Einarsdottir, executive]

Any more questions in writing? Okay. Then just on the final notes, we are happy with the results for the first quarter, and we will continue to work hard to deliver good results. Thank you very much for participating, and have a good weekend.

[Jon Guoni Omarsson, executive]

Thank you.

[Operator]

This concludes today's conference call. Thank you for participating. You may now disconnect.