Islandsbanki hf

ICEX:ISB

Earnings Call Transcript 2022-Q2

[Birna Einarsdottir, executive]

Good morning, and welcome to this webcast presentation of Íslandsbanki second quarter. I'm Birna Einarsdóttir, and I'm presenting here today. And with me is Jón Gudni Ómarsson, the CFO. Thank you very much for taking the time to be with us this morning and joining us in the middle of the summer holiday season. I'd just tell you, if it is too hot where you are, come up to Iceland. Here we have a solid 10 degrees and lot of wind.

Yesterday afternoon, we did publish our result. We are very happy with the outcome, and I'm looking forward to take you through the highlights. And then on Jón Gudni will tell you more about the finance, the details in the finances.

Like before, 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. [Operator Instructions]

And moving over to the highlights. We are presenting you today a very strong result for the second quarter with almost 12% return on equity, which is above our target. On the income side, we saw a strong growth, 21% growth, year-on-year, and the main driver being the net interest income and -- but we also saw a strong growth in our fee and commission income rising by 18%. That growth is coming from investment banking, card and payments and fee -- lending fees.

We also -- in the quarter, we saw a strong loan growth, over 4%, coming equally from households and businesses. We are expecting the loan growth to slow down in the second half due to market condition.

Our cost target this year is to keep the cost flat, the same cost as we had the year before. We have managed to do that this quarter, and we are very proud of that, and resulting in a cost-income ratio of 42.7%. The positive impairment of ISK 0.5 billion is mainly due to favorable court ruling. During our last presentation, we mentioned that we still had ISK 2 billion COVID impairments. In the second quarter, we did release ISK 0.5 billion. So we still have some reserves, and we'll watch carefully how the tourist industry will recover the rest of the year.

The capital position remained strong, and the excess capital is now ISK 30 billion to ISK 35 billion. Jón Gudni will go into that in more details later in the presentation.

In the light of the good financial result and prospects for the rest of the year, we have revised the 2022 financial guidance for return on equity up to over 10% from previous 8% to 10%. Also, we have revised the guidance for cost-income ratio to between 45% to 47% from previous 45% to 50%.

The economic recovery in Iceland is well underway as the pandemic impact fades and consumption as well as investment continues growing. And we see a limited direct impact from the war in Ukraine. Our chief economist expects the economic growth this year to be around 5% with tourism and other export taking over from domestic demand as the main driver of growth.

The tourist sector has been enjoying a strong recovery as the number of tourists are -- in this high season is now around 90% the 2019 numbers. So we are seeing a very, very strong summer for our tourist industry up here.

Pricing in the housing market had been increasing due to both limited supply of new housing and also solid demand as the household financial position remained strong and unemployment has dropped. Unfortunately, recent indicators show construction of new housing is increasing. So we hope that we will see the increase in housing prices slow down.

Along with house price increases, global inflation pressure as well as rising domestic cost pushed the inflation up to 9.9%. The Central Bank has reacted by raising the interest rate to 4.75%, and the -- and we are likely to see more action taken.

This slide is giving you an overview of the performance of the business units in the second quarter. They did all perform very well. The personal banking did continue growing their mortgage book, and they also implemented a new pension platform, online pension platform. We saw a very strong return on equity in our business banking. And in the second quarter, 8% growth in the loan book, in the lending activity. The corporate and investment banking had a good quarter also and had the highest share of equity sales and second highest in the bond market during the quarter. We saw a good inflow into our fund management company, but total assets under management decreased, though, due to the market performance.

On our sustainability front, the bank was rated -- got a top score from Reitun, that is an Icelandic rating agency, 90 out of 100 the second year in a row, something we can surely be proud of. And we are also proud that Íslandsbanki was awarded the Euromoney Reward -- award for excellence in 2022 and named the Best Bank in Iceland. And one thing they mentioned was our outstanding digital solutions. We have been on the forefront when it comes to implementing solutions for our clients' online solutions, and now we see the main growth coming from the SME clients.

In -- together with the second quarter result, we did publish an Allocation and Impact Report. We continue to focus on integrating the sustainability into the operation -- into all the operation. In 2021, sustainable lending more than doubled year-on-year, and we also saw more diverse on the sustainable asset side. We are very proud of the progress already made. However, we realize there's still work to be done, and we will surely continue our efforts here.

The Reykjavík -- the Íslandsbanki Reykjavik Marathon will be held on the 20th of August. The run is the biggest charity event of the year in Iceland and the key funding opportunity for many charities. The marathon is also another way to demonstrate in action the bank's objectives to be a force for good. And the only questions -- question you are not allowed to ask during the Q&A session is how far I will run.

Over to you, Jón Gudni. You are the marathon man, not -- right?

[Jon Guoni Omarsson, executive]

Yes. Thank you, Birna. Now I'm actually joining you here on this call from the south of France, thanks to technology. And I can tell you, for an Icelander to train for a marathon in 30 degrees, that's not easy. I'll do my best.

Over to the financials. So if we move on to the next page.

Like Birna said, we are very happy with the results in this quarter. Net interest income is growing quite steadily, and we are also seeing quite a good benefit in the net fee and commission income and, at the same time, seeing operating expenses coming down, but that's mainly due to the fact that we had one-off related costs last year due to the IPO.

Then on Page #11, you can see the details of the net interest income and, I suspect, seeing the same trend as in the first quarter, where lending volume is obviously providing some benefit and then the deposit volume as well, while lending margins are under a squeeze as rates go up. But we are more than offsetting that by increasing margins on the deposit side. Then we have other interest, and then there we have obviously the impact in our liquidity book where the interest rates, obviously, have had a direct impact. And we're obviously quite happy to see this development and seeing our margins overall moving upwards.

On the next slide, you can see the net fee and commission income, and a similar picture there as we have seen before. Good growth especially in cards and payment processing. Icelanders obviously are traveling quite substantially abroad now. Asset management is flat year-on-year and obviously had a brilliant record year last year. But we are very happy with the overall development, and I think we can say that the outlook is quite favorable for the rest of the year as well.

On to the next one. The capital markets obviously have been extremely turbulent over the past few months, as all of you on this call know very well. And as you can see here on the bottom left, we have had a big impact on our bonds, especially the liquidity book and also some other bond trading. And this is obviously a global phenomena, where interest rates have been coming up very steadily; long-term rates as well, and we have a big impact there. Offsetting that, however, we have had quite a bit of derivatives where we have fixed rate lags that -- and we have basically been hedging against some of our fixed-rate exposures in the loan book, and we see a very good benefit there, offsetting most part of the losses from the bond book. We are obviously hoping that markets will be a bit calmer in the second half of the year, but obviously hard to tell.

On the top right side here, you can see that our position in unlisted shares have come down a bit in the quarter, and the reason for this is that we are now accounting differently for our exposure to a company called Norðurturninn, and that is a company that holds our headquarters. And so we have now quite a large share. And therefore, we are accounting for that basically through our earnings as the income from the company or our part of the income. So that explains why we have shown a smaller part here in less listed shares -- unlisted shares.

On the next page, we look at the cost base. We're obviously quite happy that we have managed to keep costs pretty much flat, and the decrease -- or the overall cost decrease year-on-year is obviously because we had the one-off costs relating to the IPO last year. We are now meeting our target in terms of cost-income and doing better on that front than we expected, and that's mainly due to that the revenue was higher than we had expected this year.

The FTE numbers are still trending downwards. And -- but in terms of the cost base, like Birna said, we have seen still relatively modest impact from the global turmoil. And -- but inflation is obviously having some impact. And our biggest concern there is the wage agreements that we will have in the fall and what the results will be there. That can have a big impact next year. There, obviously, as elsewhere, workers are asking to be compensated for the high inflation numbers. But if you do so entirely, then obviously you have the risk of feeding more into the inflation. And so like I said, we will see hopefully towards the end of this year how the outlook is on that front for next year.

Yes, so if we then move to the next page. In terms of the impairments, we have a positive impact in these accounts, as we had done in the past couple of quarters. And we still have, after this, some ISK 1.5 billion to ISK 2 billion, in that range, of COVID-related impairments that we will hopefully be able to release later this year or early next year. The -- like Birna said, the tourism industry has been doing extremely well. They obviously had quite a bit of impact from COVID and especially on their -- or both on operations and then on their balance sheets as well. But the outlook is good now and they are having a very good summer. So the ISK 1.5 billion to ISK 2 billion is something that we hopefully will be able to release in the coming months or into next year.

On the top right, you can see that in terms of nonperforming loans, that ratio, the Stage 3 loans, is pretty much flat between quarters. But we see a very good decrease in Stage 2 loans, and this is mainly the loans to tourism companies which are performing better and better each quarter, basically.

Then we move to the next slide. Lending volume has been quite robust. And as you can see here, we have the biggest -- on the top left, we have the biggest increase in personal banking with very strong growth in terms of billions. But percentage-wise, we have the biggest increase in business banking. Part of that is seasonal. So our leasing arm called Ergo, they have often quite a big growth in the first half, but then get repayments after the summer months, where the car rentals, obviously, have strong cash flows. So we don't expect maybe this much growth in the second half and especially not on the mortgage side. Central Bank obviously has now raised rates quite considerably, trying to cool down that market, and so we are expecting to see less demand there in the second half.

In corporate investment banking, a 2% growth. And as we had mentioned before, we are not focused on growing that book but rather increasing the velocity of our balance sheet and helping our clients to list their shares or list their bonds in the capital markets.

On the bottom left, in terms of the LTVs, no major change there. The commercial real estate market has been performing well, and we hear that there's becoming -- some shortage there of office space, for example. So I think we can expect a bit more construction there in the coming couple of years. There's also a lot of activity on the residential front and the increase in construction, trying to meet the excess demand that we have in that sector.

So if we move to the next page. On the funding side, we have seen a good development in our core deposits, so deposits from individuals and SMEs. And as you can see there, good growth between quarters. We have not been aggressive in terms of bidding for the deposits from large corporates and pension funds and then the financial investors. And therefore, the overall base went down a bit in the second quarter.

But we can move to the borrowings on the next slide. As you can see, we have very modest maturities left in 2022, only about ISK 23 billion there, and only domestically from covered bonds. We do, however, have -- in the second half of this year, we have, in November, a callable Tier 2 bond which we'll -- obviously, we'll be seeking to call. We obviously hope to see the market circumstances improve, so we can issue at the same time. But we obviously have quite a good capital position, so we can be a bit selective there and try to find a good timing in terms of issuing that bond. We have also a callable senior bond in January. And obviously, we'll be seeking to prefund that when the markets improve.

Then on to the next one. In terms of capital position, we now know that excess capital is ISK 30 billion to ISK 35 million. We had ISK 35 billion to ISK 40 billion after the first quarter. But we -- as you have seen, we have been seeing a very strong loan growth, profitable growth. And therefore, we -- the excess capital has come down a bit. We still plan to release ISK 15 billion of capital in the coming months either through buybacks or special dividends but obviously subject to market conditions. We are a conservative bank, and we want to see the capital markets moving into the right direction before distributing too much capital.

And also, obviously, there is some uncertainty still regarding the -- our largest shareholder, whether they will participate in a buyback. And -- but this is something that we're still looking into and we'll hopefully have some news in the coming few weeks on that front.

The capital position, obviously, is still very strong and well above our internal targets and regulatory limits. And we plan to obviously retain a very strong position with a CET1 target of 16.5%.

So overall, a very good quarter and strong results, and the outlook is still quite good both in the tourism sector and the economy as a whole. The main risks are obviously the inflation and the impact on the cost base. But overall, we are very happy with the second quarter.

Back over to you, Birna.

[Birna Einarsdottir, executive]

Okay. We should now move over to the Q&A session. [Operator Instructions]. So operator, are there any questions on the line?

[Operator]

[Operator Instructions] The first question from the conference call is from Maria Semikhatova of Citibank.

[Maria Semikhatova, analyst]

Yes. I have a couple of questions. First of all, on margins, we saw such a strong performance over the quarter. I just wanted to get your thoughts on the, let's say, competition in the deposit market. You said that you're not bidding for deposits from large corporates. But how do you see other players acting? And do you expect some margin pressure going forward if competition intensifies or, let's say, the funding conditions for the wholesale don't approve?

Second, on real estate companies' exposure. There's been, of course, a lot of focus on this specific sector. Maybe you could provide a little bit of details on your particular exposure. What's the average LTV for the property companies that you have? Do you see them prepared well for this very high interest rate environment if there is, let's say, fixed or floating rate used for these companies?

And then the final is on excess capital. Out of this, let's say, remaining ISK 15 billion to ISK 20 billion after the ISK 15 billion distribution, do you expect this excess capital to be distributed before end of 2023? Or you would rather keep some cushion in case you see another quarter or so of a very strong demand from your clients?

[Birna Einarsdottir, executive]

Well, thank you, Maria. On the -- if I start briefly on the margin and the deposit. You are right, there is pressure on the interest rate that we are offering on the deposits, and we see there's a hard competition. And we have seen the interest rate that we need to offer to our -- the large clients going up. How that will develop, I think that will calm down. But at the moment, there is a hard competition about the deposit. Jón Gudni might go into that in more details.

I'm very happy with the real estate companies that we are doing business with. We have been careful in our lending processes. The sales price that the -- our clients are able to gain have been very positive. So I'm very happy with where we are, and we, of course, monitor that very closely. And Jón Gudni will then maybe add to that and take the last question.

[Jon Guoni Omarsson, executive]

Sure. Yes, a bit more on the margins. There have been increased competition on that front in terms of deposits over the past few months. And as a result, I think that's going to basically mean that we will have -- so the improvement that we have seen so far, we will have less of a trend going forward on that front, but rather retaining the margins that -- or the margin increases that we have seen so far. But obviously, there is some still uncertainty on how far the Central Bank will go in terms of the interest rates. Inflation now is moving above 10% and more than the Central Bank expected. So whether they will raise rates even more rapidly or use other tools, as they have been doing -- micro potential tools, maximum LTVs, for example, and other tools.

In terms of the excess capital, our plan is still to fully -- or basically finalize that before the end of 2023 to optimize the capital structure. And obviously, a part of it is to distribute capital. But then also, we obviously also use it when we see profitable growth, as we have been seeing in the first half of this year. But the plan is still to optimize the capital.

[Birna Einarsdottir, executive]

Is that okay, Maria?

[Maria Semikhatova, analyst]

Yes.

[Birna Einarsdottir, executive]

Thank you. Any other...

[Operator]

The next...

[Birna Einarsdottir, executive]

Yes.

[Operator]

The next question is from Piers Brown of HSBC.

[Piers Brown, analyst]

Birna, Jón, just a couple of questions from me. On the commission income, I wonder if you could just talk to seasonality there. I mean you mentioned on the lending side, but second half could be a little bit weaker in some categories. But just on commissions, I mean, you've got a huge increase in cards and payments fees in the quarter. I think it's up about 37% or something quarter-on-quarter. So is that just a summer effect, that people are out spending and traveling, et cetera, and whether that might subside as we move into the second half?

And then really just a similar question on lending demand. I mean I know in the past, we've always talked about a gradual convergence on rates of nominal GDP growth. But it does seem that the demand is still very robust. I think you're up 4% quarter-on-quarter across the various categories. So just if you're seeing any early signs that the policy rate increases we've seen in Iceland are starting to sap any of the sort of forward-looking indicators for lending growth that you may look at internally.

[Birna Einarsdottir, executive]

Thank you. Thank you. Yes, you mentioned especially the card payments, how the income there has been increasing from last -- the same quarter last year. We are now, I would say, recovering from the COVID when people are not traveling. So of course, summer is a high season, but we will continue, though, to see a strong income coming from the card business because we are recovering from COVID that we saw in the previous quarters. So I'm optimistic that, yes, the lending fee will probably go down in the second quarter on the commission side, but payment and asset management hopefully continue to be strong. Jón Gudni will add to that.

But on the lending, as I mentioned, I think the second quarter, we will see less increase in our loan book, something, as we have said, we would like to grow in line with the GDP. But of course, through the -- a business cycle, we see different research different years. But the interest rate increases is already starting to slow down the demand on the mortgage side, and we see how that will develop on the corporate side. But we have a strong pipeline, though, for example, on the SME side and on the corporate side, too. The market is -- absolutely will slow down in second half.

[Jon Guoni Omarsson, executive]

Yes. Just to add a little bit on the fee income. We do expect to see strong growth in the third quarter as well in terms of the payments. But in the fourth quarter, we actually saw the improvement there already in last year's numbers, in the fourth quarter. And so we don't expect to see as much of a difference year-on-year in fourth quarter but definitely in the third one.

In terms of lending, I agree with Birna. I think, I mean, things are slowing down. There's still a lot of interest in new investment on the -- both in commercial real estate and residential. So we are still seeing quite a bit of -- for example, as one of our -- the reason for the increase in our risk exposure amount, REA, is that we have an increase in undrawn facilities, and a lot of those are due to construction.

So basically, we see quite a bit of growth on balance sheet ahead on that front going forward. But then some of that we will then move into the capital markets, like I mentioned before. But we can also note that the SMEs, they are now facing maybe with the margin from the bank. The lending rates are maybe close to 8%. And obviously, that has an impact on their willingness to invest and where they see an opportunity there.

[Birna Einarsdottir, executive]

Is that okay?

[Piers Brown, analyst]

Yes. No, that's very clear. I mean where would you put -- you mentioned the leasing impact on the business banking number. Can you sort of put a number on that? I mean what would the underlying growth be in business banking if you took out that particular source of growth in the second quarter? Is that a material number?

[Jon Guoni Omarsson, executive]

Yes. So in total -- I mean, it's somewhere in the range of ISK 5 billion to ISK 10 billion.

[Birna Einarsdottir, executive]

We saw very strong growth there in the second quarter. Or was that first half? I think it was between -- around 15%. But that will be much less in the second half.

[Piers Brown, analyst]

And does that fully reverse in the second half? I mean is that a net reduction in the loan balances? Or is it just that you don't have an occurrence of that particular growth?

[Birna Einarsdottir, executive]

No, we have -- I think our target is that we will see some growth there overall.

[Jon Guoni Omarsson, executive]

Yes. So for the year overall, we expect to see growth. But in the second half, we do expect to see the book being rather flat. So the growth in the first half is ISK 16 billion in business banking, and we would -- yes, I think it's -- we will most likely expect it to be rather flat for the -- in second half.

[Birna Einarsdottir, executive]

Any further questions?

[Operator]

There are no more questions registered at this time.

[Birna Einarsdottir, executive]

Okay. There's one written question. And Johann is going to read it for us.

[Johann Wathne, executive]

It's a question on net financial income on Page #13, the graph on the bottom left. "On other derivatives, how are these income derived? Can you explain that in further details?"

[Jon Guoni Omarsson, executive]

Yes, sure. So these are derivatives where basically we have put hedges in place to hedge against the fixed-rate exposure. So for example, in the mortgage book, we have quite a bit of fixed-rate lending. Some of that we offset by issuing covered bonds with fixed rates as well. But we have also done some derivatives where basically we pay a fixed rate and receive floating. And there, obviously, when rates go up, as they have done substantially now in the first half of this year, we have a positive mark-to-market on the fixed-rate lag of that derivative. We have also some CPI-linked derivatives where we have been paying CPI linked and receiving a floating nominal rate and saw also some impact from there as well. But it's mainly from the fixed lags of the nominal-rated derivatives.

[Birna Einarsdottir, executive]

Okay. I hope that -- any other written questions? Okay. Oh, then we can conclude.

Just a final note. As we have mentioned, we are very happy with the results, and we will continue to work hard to deliver despite difficult market condition. Thank you very much for participating. Have a great weekend and enjoy the rest of the summer.

[Jon Guoni Omarsson, executive]

Thank you.