Islandsbanki hf

ICEX:ISB

Earnings Call Transcript 2023-Q2

[Jon Guoni Omarsson, executive]

Good morning, and welcome to Islandsbanki second quarter investor Call. As you can see here behind me, is a beautiful day here in Iceland with about 15 degrees, so very comfortable weather for the many tourists, which are roaming around the country these days.

In terms of the highlights for the quarter, you can see here, we had a very strong return on equity of 11.5% and earnings of ISK 6.1 billion, exceeding our profitability target. The main contribution is certainly strong growth in income, especially net interest income, where you saw about 23% growth between years.

Our cost-to-income ratio remains below our targets at 42.6%, having then excluded the cost of the settlement or the regulatory fine along with the settlement agreement with the Central Bank. It's very good to report that we have seen continued growth in deposits over the past few months. And at the same time, asset quality has remained very strong in spite of the higher interest rate environment here in Iceland. The second quarter was very eventful for the bank.

Towards the end of June, we made a settlement agreement with the Central Bank of Iceland. Regarding a sale of 22.5% stake of Islandsbanki shares in March last year. The bank agreed to pay a fine of ISK 1.2 billion. We had already charged ISK 300 million to our fourth quarter accounts last year. And therefore, we had now a charge of ISK 860 million in the second quarter.

Along with the fine, bank agreed on certain remedial actions to improve our operations and increase our risk culture and strength in the culture. As you can see here, we are planning to work on 6 -- and actually 7 frauds in terms of improvements. We have already made certain changes. For example, we have now changed our rules in terms of taking up calls for customers and recording calls.

And those are now in a very strict policy where we record all calls for the relevant units. We also had the strictest regulations now in terms of employee participations and trading of listed shares. And we will continue to work on various fronts to look into our corporate governance and how we can strengthen our risk culture.

We will finalize all these the steps before the end of September, so during the third quarter. And the Board will then -- or the internal auditor of Islandsbanki will submit a final report to our Board, which will be handed over to the Central Bank before the 1st of November.

Relating to this and following public and political debate after the settlement agreement, our CEO of 15 years, Birna Einarsdottir decided to step down. It's regretful that she had to step down in these circumstances after having led the bank for, as I said, 15 years and been a strong leader within the Icelandic business community as well, leading especially, for example, in terms of gender equality and sustainability.

Now on with the earnings. As I noted, our return on equity was 11.5%, so well above our 10% target. Cost income ratio was below our target and our core equity Tier 1 capital is still well above requirements at -- with a 480 basis point buffer. During the quarter, we had a change in the SREP results from the Central Bank, reducing the Pillar 2 charge from 2.6% to 2.4%.

In terms of Iceland economy, the economy, the economy continues to perform very well. Tourism is booming here in Iceland, and we expect to see above 3% growth this year. The housing market has cooled down a year ago or so. We had seen about 20% year-on-year increases. But following the rate hikes by the Central Bank, we have seen the market cooled down considerably.

And the year-on-year increase now is around 3%, which means around 5% real reduction in the housing prices. This, obviously, then again factors into inflation and helps to moderate inflation going forward. As you can see on the bottom left, the debt levels here in Iceland are quite moderate if we compare to our neighboring countries. And that, obviously, helps us to deal with these kinds of shocks.

And as noted, the Central Bank was very active and early -- you could say, early adopter of higher interest rates, and that has obviously helped to push on the inflation. We have not been seeing much impact on our customers, even though that, obviously, interest rates have gone up. In most cases, corporate clients are doing very well.

Same for individuals. Some of them are moving into inflation-linked products to reduce a bit their monthly payment. But overall, we see a very good performance in our loan book. In terms of our business units, we have seen a strong performance across the board, Personal Banking with return on equity of over 20% and also seen good growth, both in deposits and loans.

Business Banking actually have the same return on equity number as business banking, a coincidence there, but they still retain a very strong market share in Iceland and especially in the capital area. In Corporate & Investment Banking, we have seen a return on equity at 20% as well and quite a bit higher than last year. There, we factor in positive impairments, which, obviously, have a quite big impact on our earnings.

Iceland Funds had a modest increase in fee income this year. And that has to do with a drop in the capital markets that we have seen over the past year or so in Iceland. We have not seen the same increases in the stock market, for example, as -- in some other countries. And therefore, the -- obviously, with a bit lower asset base, there's a fairly modest increase in fee income.

However, there was a very considerable increase in our subsidiary, Allianz Iceland, in terms of net commission income, about 33% growth on the back of -- partly on the back of a bit of a change in the pension legislation here in Iceland.

A bit on our digital journey. We, obviously, continue to make investments on that front and make very good progress, enhancing the services, both on the online bank and also in the app. We had just recently added pension capabilities to the online bank and now trading for legal entities is available in the app.

I would like to note the Reykjavik Marathon. This is our biggest event of the year and will take place on the 19th of August. Not only is this a fun and a good exercise and a great day all around here in Reykjavik, but also there are many charities here in Iceland that rely considerably on this event. And so I would really encourage all of you to take part and, obviously, help with the charities if you possibly can.

A bit more on the financials. You can see here a bridge in terms of the earnings between years. As in the past few quarters, the biggest impact is from net interest income, which has come up, obviously largely due to the Central Bank rate. Other operating income is fairly weak in this quarter due to volatility here in the capital markets and the costs were quite high. The net impairment, however, was very positive in the quarter, and therefore, a positive impact when comparing between years. So, overall, very good return in the second quarter.

Here you can see a bit more on the net interest income. And again, we are seeing the same picture as we have seen in the past few quarters. Good growth in both -- in volume, both in lending and deposits. The margins have been improving on the deposit side coming down a bit on the lending side, but overall margin being quite stable now between quarters.

On the fee income, we can see here that the -- I would say the star performance in this quarter have been the cards and payment processing with people -- more people traveling and some changes that we have been doing in terms of our new systems there. Also, the other fees and income, that's, to a large degree, from Allianz where I mentioned before, we had a 33% growth between years.

Asset Management, I mentioned already. Investment banking is a rather soft quarter in the second quarter. And in loans and guarantees, we are seeing the volume coming down slightly, obviously, due to the higher interest rate environment. In terms of net financial income, we had a very strong quarter in the first quarter, but that is now offset by some losses in the second quarter. They come from, firstly, our liquidity book, which is fully marked to market.

And with obviously, movements in the interest rates, we have seen a bit of a negative impact there and also some of our economic hedges. In terms of the costs, our cost income ratio, as I noted before, 42.6%, when excluding the settlement agreement. And that's within our target of -- below our target of 45% and within our guidance of 40% to 45% during the course of this year. We have been seeing this in the past few months being quite cost heavy.

We have been investing quite heavily both in strategic projects. We announced, obviously, earlier this year that we -- there are strategic review with McKinsey, and we have also been using advisers on all the fronts. And then obviously, we have some costs relating to the settlement agreement and also some investments in our headquarters here in Iceland.

We will, obviously, continue to have a very strong focus on the cost side and make sure that we run the bank as efficiently as possible going forward. Now I will hand over to Johann, who is joining me here. Johann Wathne, who's Head of Treasury, and he will now talk about our balance sheet.

[Johann Wathne, executive]

Thanks, Jon Gudni. Good morning to you all. Starting with the loan book. The loans to customers grew by approximately ISK 19 billion, 1.5% during the quarter, thereof ISK 6 billion is due to inflation. As before, most of the bank's loan book is secured with very solid collateral. As can be seen from the graph bottom left, real estate is the largest single collateral.

The average LTV for the loan portfolio decreased from 59% to 58% during the quarter due to updated official real estate tax value. Loans to individuals are now approximately 50% of the bank's loan book. The bank is releasing ISK 1.2 billion of impairment this quarter. This is mostly due to reversals from a few distressed credit cases in the tourism industry, which most of you know, has a very strong outlook.

The [ probability ] rates of the economic scenarios were kept unchanged between quarters. The annualized cost of risk was minus 40 basis points during the quarter and minus 9 basis points in the first half of the year. Loans in Stage 2 decreased from 3% to 2.6% during the quarter. Loans in Stage 3, or NPLs, remained at 3%.

On to the mortgage portfolio. The book has increased by approximately 3% during the year. Majority of the growth in the second quarter was due to inflation. The credit quality of the mortgage book remains strong with 1.8% of the loan book in either Stage 2 or Stage 3 loans. There has not been a significant increase in Stage 2 or in NPLs despite increase in variable mortgage rates and high inflation, although some forbearance measures have been granted to households with mortgages.

LTV for the book has been decreasing during the year, which can be explained by updated tax valuation. It's worth noting that even if a correction in the housing market would occur, LTV levels are expected to remain within acceptable levels. households in Iceland are, overall, in a very good position, normal wages have increased and our unemployment rate in Iceland is low.

About 11% of the bank's loans to customers is in real estate and approximately 6% in construction. The real estate exposure is well diversified by collateral type as can be seen in the graph bottom right. About 50% of the construction exposure is for residential apartments; 20% for commercial real estate; and the rest is mixed. The asset quality of the real estate portfolio is solid, as can be seen in the graph bottom left.

As before, deposits continue to be the largest -- bank's largest funding source. There was a 2.1% increase in deposits in the second quarter or around ISK 17 billion. The increase mainly came from individuals and large corporates. As loans to customers increased by a similar amount between quarters, the customer loan to customer deposit ratio remained stable at 152%.

Onto long-term funding. Maturity -- vast majority of the '23 maturities have already been funded. The bank issued a EUR 300 million bond of its MTN program in May and bought back approximately EUR 251 million of the EUR 300 million maturity in November. The bank continued its issuance of covered bonds in ISK during the quarter, sold ISK 14.4 billion and bought back ISK 9.1 billion of the October maturity.

The bank has a SEK 500 million Tier 2 bond that was issued in 2018, up for a call in August. The bank will be exercising the core option at the first court date. As before, all liquidity ratios are well above both internal and external requirements, and it's worth highlighting that liquid assets, at the end of June, are approximately 20% of the bank's total assets.

The Central Bank Financial Supervision Committee recently announced the result of the SREP concerning additional capital requirements, Pillar 2 requirements. As of June 30, the bank must maintain an additional capital requirement of 2.4% of the risk exposure amount, which is a decrease of 0.2 percentage points from the previous assessment.

The bank's overall capital requirement, including capital buffers was, therefore, decreased from 19.9% to 19.7%. The Financial Stability Board has announced an increase in the countercyclical buffer in Iceland from 2% to 2.5% effective from March '24. This change will raise the bank's overall capital requirement from 19.7% to 20.2%, assuming no other changes.

The bank's CET1 ratio increased to 20% during the quarter. This is 480 basis points above the regulatory requirement and above the bank's financial target, which is to have the ratio 100 to 300 basis points on top of the regulatory requirements. The leverage ratio at the end of the quarter was 12.8%, down from 12.9% at the end of March.

As the bank has stated in previous quarters, it continues to explore share buyback options. The bank plans to continue its 5 billion share buyback plan over the coming few months and to optimize its capital structure before year-end '24, both being subject to market conditions.

On to MREL. PRT 1 has been implemented into Islandic law. The MREL ratio stood at 38.5% at the end of the second quarter which is 790 basis points above the requirement, which is 30.5%. The subordination requirement provided for in BRRD II has not been defined in Iceland yet.

All right. That concludes the opening remarks. Now we are open for the 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. You can also submit questions in writing using the webcast form. Operator, are there any questions on the line?

[Operator]

[Operator Instructions] Speakers, there are no questions over the phone. I would like to hand over to yourself if you have any written questions.

[Jon Guoni Omarsson, executive]

Okay. Very good. So this was obviously very clear. Just to conclude, as you all know, I think we have a shareholder meeting now starting at 11:00 here, Icelandic time this morning, where we will explain to shareholders the FSA settlement and the remedial actions that will be taking place following that. And there will also be a vote in terms of new Board members, and we expect to see some changes to the composition there.

As mentioned before, Iceland is doing very well. Good growth in the economy. Unemployment very low. And especially, we are seeing very strong tourism season here. The outlook for the bank, therefore, remains very favorable for the coming few months. Thank you all for joining us on this call, and have a good day.