Islandsbanki hf

ICEX:ISB

Earnings Call Transcript 2024-Q1

[BjarÂney BjarÂnadotÂtir, executive]

Good morning and welcome to Íslandsbanki this Friday where we present the financial results for the first quarter of 2024.

I'm Bjarney Anna, investor relations.

And I'm joined today by Jón Guðni Ómarsson, our CEO; and our CFO, Ellert Hlöðversson. Before I hand the session over to them, I want to mention that, as per usual, we will have a Q&A session following the presentation.

[Operator Instructions] Now the floor is yours, Jón Guðni.

[Jon Guoni Omarsson, executive]

Thank you, Bjarney. And thank you for joining this call on this rainy morning here in Iceland.

We are experiencing a rather mixed environment both on the business side and the economic environment as well here in Iceland. We are seeing general business investments being rather benign but at the same time seeing a pickup in investment in housing and the housing market picking up in general. The outlook is fairly good, but at the same time, we are seeing that some of our customers are experiencing the high rates are having an impact, but we are not seeing impact on that in terms of delinquencies or the quality of our loan book, at least to a very small degree. So like I said, a bit of a mixed environment.

If you look at our results for the first quarter. We had a 9.8% return on equity, which is in line with our guidance which was around 10% and slightly below our 10% target. The cost-to-income ratio was below our target of 45%. The first quarter is generally fairly high in terms of costs, for example, in terms of leave and some other cost items, so a relatively high cost-income ratio in this quarter.

The capital position remains very strong. And as Ellert will describe later on, we had the opportunity to go into further buybacks this year. And as I noted, asset quality remains quite robust even though, like I said, we see that some of our customers are feeling a bit of the pain of the high interest rate environment. And some of them are using the opportunity to move over into inflation-linked products.

In terms of -- like I mentioned, our guidance for the year remains to be at around 10% return on equity and the cost-income ratio obviously below 45%. And in terms of the capital, we are quite well overcapitalized and well above our targets.

In terms of the economy, we are seeing GDP growth calming down quite a bit from last year. Last year, we had some continued pickup basically from the COVID area -- era. And so now we are seeing basically a normalization, I will say, in terms of the growth. And obviously, with the higher interest rate environment, the central bank is doing its part to cool down the economy, so we expect growth around 2% this year; and then reach more normal levels, the year after, of around 2.5%.

The housing market has been slowing down over the past few months, I could say, and then last year, for example, price increases were very modest. And we felt a quite sharp cooling, in the last quarter of last year, in terms of new construction projects, but we are seeing that picking up now. And the seismatic activity in Grindavík has had a bit of an impact on the market, where the inhabitants of the town have been going into the market; and so we see more the demand. And that seems to be also pushing for new construction projects, which we have been seeing starting now.

Like I said, we obviously are running at quite a high interest rate environment, where the central bank rate is still 9.25%. And the market is not expecting a decrease until probably in the third quarter or even the fourth quarter of this year. The annual inflation now is down to 6%, which means that we're -- have the real rates of around 3.25, so quite high real rates. And this is obviously impacting some of the investment levels. Inflation is expected to come down to around 5% towards the end of this year. And we'll obviously see how that will counteract with changes in the policy rates. And that can have a -- quite a sizable impact on our earnings, as we are running an inflation imbalance where we have more inflation-linked assets than liabilities, as Ellert will describe a bit more later on. So we can see some fluctuations in our earnings due to this interest rate environment.

Moving ahead, in terms of the first quarter for the bank. Like I said, there was fairly strong activity on many fronts. Especially, you're seeing the housing market picking up. In terms of business-wise here, our corporate finance unit is quite active at the moment and is now preparing the listing of Íslandshótel, a hotel operator here in Iceland, which will obviously be exciting to see, hopefully, in this quarter. We -- in terms of our capital markets activities, we have a very strong position now with -- in terms of equities, with the highest market share so far this year.

We continue to make quite substantial investments in our technology. And our chatbot got nominated for 2 international awards in the first quarter, which we obviously are very happy to see; and we continue to develop that quite rapidly. And at the same time, we are also working on a internal chatbot based on generative AI. And that's in beta testing already; and will be a new tool basically for our employees to use, obviously, to help, I mean, in terms of their work, yes. So quite a few activities.

And obviously the biggest news from the quarter was the increase in the rating or the rating upgrade from S&P moving us to BBB+, which we're obviously extremely happy to see.

In terms of infrastructure, we see a lot of opportunities in infrastructure here in Iceland and ample opportunities there in the years ahead and the quite big investment needs on that front: the road systems, obviously, and bridges; the energy transformation, for example, with wind farms; and on many other fronts, airports, telecommunication, yes. And so we are seeing this in the hundreds of billions of ISK in terms of the investment need for the next 10 or 20 years. And here we can play a crucial part both with our balance sheet but also with our services, corporate finance, funding, FX and bond issuance. And here we plan and can definitely make -- we'll be a force for good and have a positive impact on the local environment here in Iceland.

We also want to note that we own a plot here in Reykjavík, where we used to have our old headquarters, called Kirkjusandur. We have now finally decided that we are not moving our headquarters back to this plot. And therefore, we have changed the accounting method and may move this into basically fair value, you could say; and seeing a bit of an impact on our earnings, as a result, in the first quarter, which Ellert will describe a bit later on, but in terms of the plot itself, it's an extremely good location in Reykjavík, a good opportunity and about 26,000 square meters, a number of apartments of around 200 to 250. And we are now basically in the final stages of development and then -- and plans for in terms of the potential sale of this plot going forward. So for the domestic investors here in Iceland and obviously [ all who's here ], I think this will be a very interesting opportunity.

We are now quite focused on financial health, based on we have been seeing that our customers are increasingly worried about their financial health due to the high interest rate environment here in Iceland. And that's probably something that we're seeing internationally as well. And here we can actually play a fairly big part, and therefore, we are promoting in our messaging outwards, yes. And first of all, we are beefing up our education on this front. We are making our advisers more accessible, where customers can book time slots to have discussions. And we are also adding activities and services in our online channels, and we'll also be developing more products to help customers on this front.

Not only are we looking at financial health but also physical and emotional. On the emotional front, we want to continue to make Íslandsbanki a great workplace and focusing our efforts on that quite substantially on many fronts, promoting health in general across the workplace. Externally, we have the Íslandsbanki Reykjavík Marathon, which is the biggest charity event of the year and something that we are now starting to promote for the summer and obviously expect to see a great attendance and a lot of funds being raised for various charities. So a lot going on, on this front both internally and externally as well.

So having gone through that and some of our plans for the next, the coming months; and the general environment, I'll now hand it over to Ellert to give you a bit more detail about the financials of the bank.

[Ellert Hlodversson, executive]

Thank you, Jón Guðni.

Turning over to the financials. Profit for the quarter amounted to ISK 5.4 billion; and return on equity, 9.8%, as Jón Guðni stated before. Year-on-year, the operations were impacted by fixed rate imbalance, the CPI imbalance, yes, and also fixed-rate reserves for the NII. During the quarter, as stated before, we reclassified Kirkjusandur, the plot we owned, as investment property; and realized a fair value gain of ISK 900 million. We are exploring to what extent we will be developing further and we'll provide updates as things mature.

We experienced unfavorable market conditions, which were leading to high effective tax rate of 31.3%. This is primarily due to loss related to equity holdings used for hedging against forward contracts, but if we look at the NII, as I stated before, the fixed rate imbalance and the CPI imbalance continue to have adverse effect on performance. Further, the central bank raised its fixed-rate reserves from 1% to 2%, effective June 2023, which has an effect on year-on-year comparison. A second raise in the fixed-rate reserve from 2% to 3% came into effect this April. Given the current rate environment, each percentage point is estimated to have a cost of over ISK 900 million. Despite this, we see an increase in net interest margin quarter-from-quarter, that is from Q4 '23 to Q1 '24, where margin grew from 2.9% to 3%.

During the quarter, the policy rate remained unchanged at 9.25%. Inflation, however, varied, going from 0.4% to negative 0.16%, up to 1.33% accounted for in March. Analysts assume that inflation will continue to subside and policy rates will be cut followingly. As stated earlier and Jón Guðni came -- touched on before, given the current loan book composition, we expect that income volatility may be experienced while this trickle through our books.

On the fee side, cards and payment processing remained the largest net fee and commission income. Although, the cost related to payments has gone up, impacting year-on-year comparison, which is mainly related to scheme fees. Investment banking and asset management fee income continues to be pressured due to market conditions. Advisory pipeline, however, remains strong. And capital market valuations support overall positivity. In addition, we would like to mention that Allianz, our insurance subsidiary, is turning out quite a healthy contribution to net fee and commission.

Market conditions also affected the net financial income during this quarter. As stated before, we are experiencing a high [ net ] tax rate or effective income tax rate related to economic hedging. Further, market conditions unfavorably affected [ old ] yield curves. As before, we have limited market risk exposure [ on our books ], amounting to ISK 5.1 billion end of quarter 4 for listed shares compared to a ISK 2.3 billion end of the year 2023.

Looking at costs. Cost-to-income closed at 44.7%, within our targets of 45%. Year-on-year, expenses rose by 5% and amounted to ISK 7.4 billion end of the quarter.

Salaries were growing 5.2%. That is mainly on back of additional employees hired year-on-year, which is with regards to our ongoing commitment to further strengthen our regulatory infrastructure and overall governance. In addition, we have made provisions within the quarter related to the expected outcome of the general wage union agreements which have not been concluded for the union to which our employees reside. We would also like to note that there is a seasonality, as before, in our salaries where accrued leave is being accounted for in the first half of the year and then being reversed during the summer.

Other expenses rose by 4.7% mainly due to inflation; investments in IT; and as Jón Guðni stated, the first half of the year being more cost heavy than before -- than the second half, sorry.

And turning to the balance sheet. Loans to customers closed at ISK 1,248 billion, growing by 2% from year-end 2023. During the quarter, all business segment were growing, while CIB was growing the largest, by 3%. As before, the loan book is well diversified. 43% of the book is in mortgages, and individuals additional -- 5 percentage more. The remainder is well diversified between industries. A gradual increase has been seen with construction, which we'll touch on later on.

The bank has a conservative credit culture, which can be reflected in the risk classes on the lower right-hand side, where our borrowers tend to reside in the lower-risk classes. Average LTV closed at 57%, flat from previous quarter despite high interest rate and high inflation.

Cost of risk was 22 -- 23 basis points during the quarter, within our guidance of 25 basis points throughout the cycle given the current loan book composition. A total of ISK 700 million was account for as impairment allowance, mainly related to a few distressed cases. We would like to emphasize that we are not seeing delinquencies rising to any significant at this point in time.

Stage 2 loans remained flat at 3.3% during the quarter, from year-end 2023. To recall: Stage 2 loans were increasing from Q3 to Q4 in 2023, which was mainly due to the seismic activity at Grindavík, where uncertainty is still high. Stage 2 (sic) [ 3 ], however, remained stable, growing by 0.1 percentage points from 1.8% to 1.9%, within healthy limits, providing an overall good asset quality reflection. And taking into the mortgage book, credit quality also is good at that front. Stage 2 and Stage 3 remained flat quarter-on-quarter, having increased, as stated before, in Q4 2023 based on the activity in Grindavík, the seismic activity.

As previously stated, we are seeing a continuous shift where borrowers are refinancing their mortgages through CPI-linked instruments. This is a way for customers to manage their repayment [ proper ]. As of now, 56% of the mortgage book is within various CPI-linked instruments compared to a 53% year-end 2023. Our CPI imbalance closes off at ISK 175 billion end of quarter compared to a position of ISK 129 billion end of 2023, both on the back of mortgages as well as corporate loans and other loans to individuals.

On the other hand, interest rate resets for 3- and 5-year fixed mortgages are ongoing, relieving the fixed interest rate imbalances within the banking book. On the upper right-hand side, you will see that a total of 29 billion are up for reset throughout the remainder of this year compared to a 9 billion which was accounted for in the first quarter. Next year, subsequently, 52 billion are up for reset. All in all, the mortgage book is in a healthy shape. NPLs are low and LTVs remain flat as before given -- even though we have high interest rates and high inflation.

Our exposure towards real estate and construction grew by a total of 3% during the quarter and amounts to 12% and 7%, respectively, of the loan book. [ As breadth of ] primary issuances [ or ] capital markets domestically comes down, some of this exposure may be refinanced to the capital markets. Despite commercial real estate being pressured on both sides of the Atlantic, the Icelandic sector remained strong. Occupancy ratios are high. And the listed companies are reporting an occupancy ratio around or over 95%. Further, those exposures are primarily CPI linked, where the real estate companies have CPI-linked rental agreements providing them with a natural hedge.

On the construction side, we would like to emphasize that it's -- that disbursements of loans are linked to progress in construction. Further, half of the exposure relate to residential real estate, where analysts forecast increased demand.

And on to liabilities. Deposits remained the largest funding source for the bank, as previous years, at 48% end of the quarter. Depositor concentration is stable, where 11% of the deposits belong to the 10 largest depositors. Over half the deposits are related to individuals or ISK 443 billion, growing 4.2% since year-end 2023, while other segments remained flatter.

And the funding is off to a good start. At the beginning of the year, we issued a -- 3-year NOK 500 million and SEK 500 million senior preferred green notes; and in March, a new 4-year EUR 300 million bond which was issued at 185 basis points over mid-swaps, considerably tighter than the previous 2 years. In addition, we issued ISK 5.3 billion 5-year senior preferred in the domestic market. As a result, our FX funding requirements for this year have been well advanced. During the year, a SEK 500 million Tier 2 is expected to be called at the first call date. No decision has been made on issuances in the Tier 2 space given the strong capital position.

Early April, S&P announced a rating action raising our rating to a BBB+ on a stable outlook. This was primarily on the back of rescinding economic imbalances within Iceland. We have also an A3 issuer rating from Moody's since last year. Overall, market access is strong both internationally and domestically.

In terms of liquidity, the bank has a strong position, where total LCR is 190% and the LCR for ISK closes at 101%. NSFR remained stable throughout the period. Our liquidity portfolio amounted to ISK 325 billion, representing 20% of our total asset base.

Start of the quarter, we reclassified the liquidity book so that it's now held marked to market at fair value through OCI compared to a fair value through P&L which was classified before in 2023. This better reflects how the liquidity portfolio is being managed. Assets within the book that reside from 2023 will not be reclassified to go over OCI, but new assets will go through OCI. As before, the entire book is held at mark-to-market. And there are no unrealized costs due to mark-to-market movement in the book.

And lastly, turning to capital. Our total capital ratio closed off at [ 23.8% ] compared to a 25.3% year-end '23, where deduction planned, ISK 10 billion related to buybacks, played the larger part. Preliminary analysis has been conducted with regards to the implementation of Basel IV, indicating that a REA reduction will take place, providing capital relief and paving the way for additional CET1 disbursement. At the end of Q1, CET1 position was 420 basis points, ahead of requirements. Given the management buffer or the current management buffer, there are ample opportunities for disbursement of excess capital.

During the quarter, an AGM decided on a ISK 12.3 billion dividend payment, which was paid on the 2nd of April. Buybacks are also occurring. The bank plans to optimize its capital position before end of 2025. To that extent, the bank may, in addition to internal or external growth, explore capital distribution in the form of ordinary share buybacks, buybacks via reverse auction and/or extraordinary dividends in order to reach its target capital composition.

With that, I hand it over again to Jón Guðni.

[Jon Guoni Omarsson, executive]

Thank you.

Just to sum up. Our results for the first quarter are in line with our guidance for the year; and our updated guidance for the full year is in the same line, at around 10%. The Icelandic economy seems to be on route for soft landing with a bit mixed business environment, as I described earlier. Íslandsbanki is very well placed in this market and obviously to reap the benefits from -- for an uplift in the economy and in the capital markets that we're expecting when the interest rate levels start to come down. And as Ellert described, we are planning on further capital optimization in the coming few months.

Having said that, I think we should move over to questions. Over to you, Bjarney.

[BjarÂney BjarÂnadotÂtir, executive]

Thank you, boys. And we now open for a Q&A session. [Operator Instructions] Operator, are there any questions on the line?

[Operator]

[Operator Instructions] And the first question comes from the line of Sofie Peterzens from JPMorgan.

[Sofie Peterzens, analyst]

Yes. So you mentioned that the Basel IV could be a small positive impact or positively [ impacts to delever ] risk-weighted assets. Is there kind of -- can you somehow quantify it, what it actually would mean? Like what magnitude of impact it could potentially have. And also if you could just update us on the latest with the government stake and, yes, if there is any update here. And did you do a directed share buyback to the government as you continue with your capital optimization?

[Jon Guoni Omarsson, executive]

Okay, I can then start with the -- in terms of the buybacks and the government stake. All buybacks that we will plan would be directed towards all shareholders, not particularly towards the government, just open to all shareholders. In terms of the government stake, there's a bill now before parliament in terms of giving the ministry of finance the authority to continue the sell-down, and we are hoping that, that bill will pass in the next few weeks. And the government has stated its intention to sell probably half of the remaining stake during the course of this year; and the other half, next year. Then Ellert, in terms of Basel IV, over to you.

[Ellert Hlodversson, executive]

Yes. In terms of Basel IV, I mean, preliminary analysis is taking place. We have been going through it and it's -- I mean the amount is measured in -- I would say, in tens of billion ISK, ISK 50-ish billion, but since, nothing has been imposed into regulation. If -- there's still uncertainty to what extent, I would say, especially mortgages will be reflected in the Icelandic legislation, which may have a meaningful impact to either side.

[Operator]

[Operator Instructions] And the next question comes from Piers Brown from HSBC.

[Piers Brown, analyst]

Yes. I've got 2 questions. One is on the CPI imbalance. I don't know whether you actually gave the number that's embedded in net interest income this quarter, but I'd be interested to hear if you have -- there's a figure on Page 12 of the slide pack of minus, I think it's, ISK 168 million for other items in NII. If you could just clarify if that's CPI. And then the second question is in the press release there was reference to an AML case that you may need to settle and potentially be -- book a fine for. If you could just quantify: Is that something that could be material for our modeling purposes?

[Jon Guoni Omarsson, executive]

Okay. So I'll start with the AML. That's actually something we described, I think, in our Q4 results; and then again now, basically in the notes. And this is basically an outstanding item. And we have actually already met all the requirements from the regulator in terms of changes, and that has been implemented already. However, they will be coming formally out, probably in the next few weeks or a couple of months, with the final results. And it's hard to say whether it will be a fine. And at the same time, it's also extremely difficult for us to quantify if there is a fine, so yes, it's difficult for me to mention a number, but -- and so the uncertainty is a bit there, but like I said, we have not like seen any particular or we haven't experienced any money laundering through the bank; no evidence of such. And at the same time, we have already met the requirements from regulators, so we certainly hope that, that will have a big impact on any potential fine amount. Then in terms of the CPI imbalance, Ellert, over to you.

[Ellert Hlodversson, executive]

Yes. First of all, on the AML issue, within the [ contingency ] note, we state that we have provisioned an undisclosed amount relating to a potential fine. Just to add that. On the CPI amount: There was a slight loss during the quarter -- or slight calculated loss during the quarter measured, I would say, somewhere midway between 0 and 100 billion -- ISK 100 million.

[Piers Brown, analyst]

Can I just follow up? Can you just talk through the mechanics this quarter of the CPI, why that's a negative item within interest income?

[Ellert Hlodversson, executive]

It's also -- this has much to do with how we calculate things. Obviously we fund -- the CPI loans are primarily funded with nominal deposits and nominal issuances, so how we account for these things with regards to, I would say, the loss of opportunity, to some extent, has a big part to play with it. If you look at the imbalance itself, it has been growing, so you can't really view it as, I would say, is in [ a static state ], but I think it could be, I would say, beneficial for all analysis if we provide, I would say, some actual material detailing how this goes through our books. It's kind of difficult to go through the mechanics during the webcast.

[Jon Guoni Omarsson, executive]

Yes. So maybe just a very...

[Piers Brown, analyst]

Yes. I appreciate that, yes. I'm just...

[Jon Guoni Omarsson, executive]

Just a very brief example. If nominal rates are at around 10%, and real rates around 3%, and then -- and 7% inflation, then it's around 0, the impact, that P&L impact, from the CPI imbalance, but what the -- obviously the risk is now for the short term is that the nominal rates stay at quite a high level while inflation starts to come down. So for example, in that inflation example, if inflation then goes down to 5%, then the overall impact -- so then we have 3% real rates, plus 5% inflation, at 8%. And there that we -- there we can see a temporary loss. And then obviously nominal rates are expected to come down fairly quickly as the inflation comes down. And we obviously have also some opportunities to then raise the inflation -- or the real rates to mitigate against this as well.

[Ellert Hlodversson, executive]

Yes. And if I add a bit to that. I mean high inflation is no new -- that's not a news to Iceland. We have -- traditionally have had high inflation. We have had high interest rate environment going up-and-downs in cycle all throughout our economic history. This is something which we've seen before and we know how to manage it. We're taking a balanced approach. And we'll provide some material to the analysts detailing how this goes through our books.

[Piers Brown, analyst]

Okay, that's very helpful. Can I just -- one final thing on that. If I look at the balance sheet and the -- so the reported loans-to-customer number, which I think has grown 2% quarter-on-quarter. Presumably that's impacted by effectively revaluation of the CPI-linked loans. Is that correct? I mean, is it possible to figure out what the underlying rate of growth is if you strip out the CPI impact on the balance sheet?

[Ellert Hlodversson, executive]

Yes. This is adjusted for inflation. So high inflation goes through as higher end-of-quarter position.

[Jon Guoni Omarsson, executive]

Yes. And that's, yes, we can certainly provide that to give you a bit more details on how much of the growth is through the inflation versus real growth.

[Operator]

There are no more questions at this time, so I hand the word back to you, Bjarney.

[BjarÂney BjarÂnadotÂtir, executive]

Thank you so much. We haven't received any written questions, so we're concluding this session. And we thank you all for joining and hope you have a good weekend.

[Jon Guoni Omarsson, executive]

Thank you.

[Ellert Hlodversson, executive]

Thank you.