Islandsbanki hf

ICEX:ISB

Earnings Call Analysis

Íslandsbanki reports strong Q3 earnings and cautious outlook

Íslandsbanki's third quarter saw a robust ROE of 13.2% and a cost-to-income ratio of 44.2%. Positive impairments of ISK 900 million boosted earnings, while net interest margins fell to 2.9% from 3.1%. The bank anticipates an annual ROE of around 10%, expecting Q4 results below this mark due to higher costs and inflation volatility. With a strong capital position (CET1 of 23.4%) and resilient asset quality, the bank is preparing for future government share sell-downs post-elections. Economic conditions suggest low growth this year but recovery is expected in the next, with increased activity in capital markets.

Overview of Earnings

In the third quarter, Íslandsbanki reported robust earnings with a Return on Equity (ROE) of 13.2%, exceeding expectations. The bank's cost-to-income ratio stands at 44.2%, indicating efficient operational management. Key factors contributing to these results include positive impairment reversals totaling ISK 900 million, bolstered by enhancements in credit models that utilize historical data for better loss predictions.

Impact of Economic Conditions

The Icelandic economy is currently facing volatility, primarily due to fluctuating inflation rates. The bank's net interest margin has declined from 3.1% to 2.9%, significantly influenced by inflationary pressures. While the bank experienced a CPI tick of 1.04% during Q3, it anticipates a drop to 0.36% in Q4. This environment may exert further pressure on margins, especially if rate cuts are not implemented swiftly.

Future Guidance

Looking ahead, Íslandsbanki has revised its annual ROE guidance down to around 10%, anticipating that Q4 earnings will likely dip slightly below this figure due to increasing costs and uncertain impairment outcomes. The fourth quarter is typically heavier in costs, adding to this cautious outlook. Despite these challenges, the bank's outlook remains generally optimistic based on its strong asset quality and balance sheet.

Market Trends and Opportunities

Although economic growth is projected to be modest this year after a period of rapid expansion, there is optimism for recovery and stronger growth projected for subsequent years. Key sectors, particularly land-based salmon farming and infrastructure projects, are poised for significant investments, which could stimulate growth. Additionally, the bank expects an increase in capital market activity, especially as interest rates decrease.

Capital Position and Strategies

Íslandsbanki maintains a strong capital position, with a CET1 ratio of 23.4% against a regulatory requirement of 19.7%. With management aiming to optimize capital before year-end 2025, the bank is well-positioned for shareholder distributions, including potential buybacks and dividends, subject to market conditions. This strategy indicates a commitment to both growth and returning value to shareholders.

Government Stake and Future Prospects

The upcoming early election in Iceland has delayed the government's planned sell-down of its stake in Íslandsbanki. The new government will have to decide on the timing of this sell-down, but there is an overall optimism that it will benefit infrastructure funding and divestment strategies. The bank is confident that preparations are in place for any future transactions.

Operational Highlights

All business units reported strong performance during Q3 with increased activity in capital markets and asset management. The bank has also enjoyed the highest turnover in the Icelandic equity markets for nine months this year, solidifying its dominant market position. Additionally, the emphasis on financial health amid rising interest rates underscores the bank's focus on providing valuable solutions to its clients.

Earnings Call Transcript 2024-Q3

[BjarÂney BjarÂnadotÂtir, executive]

Good morning, and welcome to Ãslandsbanki this Thursday, where we present the third quarter results of Ãslandsbanki. I'm Bjarney Anna with Investor Relations, and I'm joined today by our CEO, Jón Guðni Ómarsson; and CFO, Ellert Hlöðversson. Before I hand the session over to them, I want to remind you that as per usual, we will have a Q&A session following the presentation. [Operator Instructions]. And now, the floor is yours Jón Guðni.

[Jon Guoni Omarsson, executive]

Thank you, Bjarney, and thank you all for joining. As you can see here behind me, the days are getting a bit shorter here in Iceland and winter is coming. But at the same time, I think we can safely say that spring is coming to the Icelandic capital markets. The Central Bank had its first rates decrease in September, and we have seen a very good pickup, especially in the equity markets since then. And obviously, we are hoping now for inflation to come down quite quickly and further build up in the capital markets. As most of you have heard, the Ministry of Finance here in Iceland had planned to start to sell-down or continue the sell-down of the government stake in Ãslandsbanki later this year. We are obviously a bit surprised as everyone here that there was a call for early elections, which will take place on the 30th of October -- November, sorry. This obviously means that the planned government sell-down will be delayed. But if we look at the glass being half full, we can say that this gives us more time for preparations. And it will obviously be up to the new government to make their plans in terms of the further sell-down. But at least we will make the bank ready and be sure that everything is ready when the new government plans to start the sell-down.



The third quarter, we saw very good earnings for the bank, ROE of 13.2% and the cost/income ratio below our targets, which is for the first 9 months at 44.2%. We are seeing here quite a big impact from positive impairments, which came close to ISK 900 million for the quarter, and partly due to an update in our credit models where we are using obviously historical data to predict further losses. And with enhancing those models, we could release part of our impairments. We also saw a bit of an uplift due to an increased valuation of the building I'm standing in here, which is partly owned by the bank. And also, in the third quarter, as usual, we see costs being a bit below what we see in other quarters due to seasonality and accrued leaves.



The bank remains obviously extremely well-capitalized, and we continue our plans to optimize the capital structure before the end of next year. Asset quality also remains very robust. Stage 3 loans actually come down slightly in the quarter, partly due to one nonperforming loan, which has been now going through restructuring, and we have taken over the underlying properties, which were held as collateral. But at least it's very comforting to see that the nonperforming loans have not risen in the current environment. We see a slight increase in the Stage 2 loans. But obviously, with hopefully, interest rates coming down now in the coming months, we hope that we won't see a further rise in that measure.



Now, moving to the targets and the guidance. We are obviously meeting our targets so far this year, and actually, obviously, well above it for the third quarter, especially in terms of return on equity. We are, however, guiding towards that we expect the ROE to be at around 10% for the year as a whole. And that means that we can expect that the fourth quarter will be somewhat below 10%, obviously, highly dependent on impairments. The fourth quarter tends to be a bit more heavy in terms of the costs. We are also seeing a volatility in our earnings due to the inflation imbalance, and we are expecting quite low inflation in the fourth quarter. But Ellert will take you a bit more into that a bit later on in the presentation. But as I said, due to these fluctuations and assuming relatively normal impairments, we can expect somewhat below 10% earnings in the fourth quarter. And we, as I noted, expect earnings to come at around 10% for the year as a whole.



Moving to the economy. First here, a slide on the economy and the broad picture of the Iceland economy as a whole. Iceland obviously scores quite well, both in terms of society and also the public finances and finances across the board. One thing I would like to note here on the bottom middle picture is that we have been looking at the intellectual property industry as a whole. Intellectual property is obviously within pretty much every industry from pharmaceuticals to computer games. But if we take the intellectual property generated in Iceland as a whole, that is actually closing in on seafood in terms of export revenue. And therefore, we can say that the exports here in Iceland, we are seeing even more broadening base, and the intellectual property being basically as a fourth pillar to our exports, along with energy, tourism and seafood.



If you look at the current economic environment, the growth is expected to be quite low this year, following obviously very strong growth in the past 2 years. We then expect to recover quite quickly and then see stronger growth next year and then further in 2026. This is on the back of, obviously, new investments, quite a bit of investments needed here in the infrastructure. There's quite a few projects here in the land-based salmon farming, and quite a few other initiatives that we expect to see fuel growth going forward. Inflation has been coming down quite steadily. And on the bottom left here, you can see the expected monthly tick. And as you can see, it can be quite varied between both months and then quarters as well. And as we have seen before and we have noted, and I think all investor meetings, the bank, and actually the banks here in Iceland are now becoming a bit long inflation. And that means that the inflation take in each quarter has an impact on our earnings. Then over the next year or so, year or 2, we expect obviously this environment to moderate, that the inflation will come down first and then the Central Bank rates will follow fairly quickly to a normalized level.



In terms of the operations in the quarter, very active across the board. All business units doing very well, and business in general, quite strong. As I noted, obviously, we are seeing a spring in the capital markets, and we have high hopes that we will see good increase in liquidity in the capital markets, and obviously, then enhanced revenue following from that. Assets under management are expected to grow in the coming quarters. We have seen a strong inflow into deposits over the past couple of years with fairly weak capital markets. And therefore, we expect to see some movement from deposits back into the -- both the bond markets and the equity markets going forward.



We continue obviously to invest in our digital products and infrastructure. Continue to add new features, obviously, to our clients, and making very good progress on that front. In terms of market shares, we had a recent poll where customers are asked in terms of SMEs, who are they banking with. And we continue to -- we have an extremely strong position there in SMEs at around 39% for the capital area and slightly below that for the country as a whole. We have enjoyed the highest turnover in the equities in the capital markets here in Iceland in the first 9 months of this year. And our corporate finance team remains very busy. So, throughout and across the board, very good operations and a lot of activity across the business units.



Financial health has been a key topic for the bank now for the past few months. And you could say a silver lining through our development of offerings, both in terms of products and services to our clients. The current economic environment and obviously high interest rates has put a strain on both companies and individuals, and therefore, financial health and promotion of products and solutions on that front is extremely important. At the same time, we want to focus on health across the board, also for our employees and obviously, in society as well, where the ReykjavÃk Marathon is the biggest event of the year on that front. And we also look at other initiatives on that front. So, like I said, financial health and health overall is a silver lining going forward in the next few months in terms of operation and services for the bank and how we service our clients. Then I think it's time to go over to Ellert and look a bit more in detail at the numbers. Over to you, Ellert.

[Ellert Hlodversson, executive]

Thank you, Jón Guðni. If we look at the quarter, the key drivers for results for this quarter were the effect of the CPI imbalance, as discussed before, inflation, as well as impairment reversals. In addition, we had, as Jón Guðni stated before in his presentation, we had value-added increases to the property we own here at Norðurturninn containing the bank's headquarters. But taken into interest, if we start with that. During the third quarter, we see net interest margin dropping from a previous level of 3.1% down to 2.9%. This is on back of the effect of the CPI imbalance in particular. During the third quarter, the bank accounted for CPI ticks amounting to 1.04%. When we last spoke at the second quarter earnings call, the macro forecast assumed that the inflationary tick over the third quarter would be 1.28%.



So, as we see, inflation is subsiding more rapidly than we previously anticipated. This has been followed by a rate cut by the Central Bank at the beginning of October, and the next rate decision is coming at the 20th of November. Should the macroeconomic forecast for Q4 materialize, the bank expects to account for 0.36% of inflationary ticks compared to the aforementioned 1.04% in the third quarter. As obvious, this is going to provide strain and pressure on our margins over the next few quarters, while inflation comes down if policy rates are not cut at the same pace. However, for the medium-term, the bank believes that this real rate are positioned in a suitable manner. Further, the fixed rate imbalance, which is currently on our books, and we will come back to at a later stage in the presentation, is continuing to subside, which is counter affecting the CPI impact to some degree.



The other side of rate cut and subsiding inflation is obviously more activity. We have seen throughout the third quarter and into the fourth growing activity, especially on the capital markets. For the last few quarters, income due to asset management and investment banking has been tapered due to, I would say, limited activity on the capital markets. But as rates are being cut, we expect capital markets to turn their sentiment and recover, paving the way for future growth on both the asset management as well as the investment banking side. Further, lower rate environment is expected to increase overall lending activity, paving the way also for increased lending fees in the future quarters. As previously, our subsidiaries are contributing healthily to our profits, especially Allianz, which continues to have good results.



In terms of market risk and financial income, as before, our market risk is limited. We closed off at around ISK 5.5 billion end of third quarter compared to a position of 6.7% from an equity standpoint at the close of the second quarter. Strategic positioning, especially of the liquidity book and favorable development of yield curves are yielding slight profits from net financial income over the third quarter. Focusing on costs. As Jón Guðni stated, third quarter is seasonally lower in costs compared to the other quarters of the year due to mainly accrual and usage of holiday leaves as well as limited activities in the bank over the summer period. The bank accounted for during the quarter, salaries rose by 12.9%, but there within is a one-off cost related to streamlining efforts, which included redundancies, which was accounted for in the third quarter. Year-to-date, our cost-to-income ratio is at 44.2%, and we are guiding towards a slightly in excess of our target of 45% for the year as a whole.



Looking at other operating expenses, they grew as well quarter-on-quarter, third quarter on third quarter, mainly related to our continuing efforts in IT investments, which we expect to yield results in further streamlining down the road. Turning over to the balance sheet. The loan portfolio was more or less flat throughout the third quarter, again, related to lower lending activities historically over the summer period. Broadly speaking, the composition of the loan portfolio remained the same with mortgages moved from 43% to 44% and the rest of the portfolio is a good reflection of the Icelandic economy. Over 94% of the loan portfolio is secured with collateral of various types. LTVs averaged at 56%, same as the previous quarter and similar to the previous quarters -- previous few quarters. As before, the bank is rigid in its terms of credit quality, and we aim towards the lower risk borrowers as seen on the lower right hand side on the slide.



Looking at asset quality, we saw reversals of impairments amounting to ISK 860 million in the quarter, thereof around ISK 500 million related to recalibration of loss given default models. This relates to a negative 27 points cost of risk in the quarter or negative 3 points over the first 9 months. We have seen asset quality being quite strong, as shown in the top right hand slide. Stage 3 loans lowered from 1.8% down to 1.6%, among others, related to foreclosure of a non-performing asset during the third quarter. Increase in Stage 2, which you can also see from second quarter into the third quarter relates to a handful of distressed cases rather than a systematic-wide disruption, if you will. The bank is seeing some signs of increased difficulties for borrowers, mainly in the unsecured part of the lending book, which remains a small part of the lending book. As of now, we have seen limited effects coming into -- I would say, coming into significant defaults despite the high inflation and the high interest rate environment.



Looking at the mortgage book, this is more of the same story. There was a slight growth in the mortgage book over the quarter, and we continue to see the shift from nominal rate mortgages into CPI-linked mortgages. Asset quality on the lower right hand side remains strong, where NPLs are flat at 0.9% and a slight reduction in Stage 2 loans. LTVs remain both stable and healthy at 57%. Looking at the top right hand slide, you will see the refinancing profile of the fixed rate imbalance. The bank is currently refinancing around ISK 10 billion to ISK 15 billion over the next few quarters of fixed rate mortgages, which are then being reset into current rate environment, relieving the imbalance, which has been adversely affecting our operation for the last few quarters, thus counter affecting the CPI imbalance effect to some degree.



From a CRE perspective, yet more of the same story. We're seeing growth -- limited growth in the portfolio. High-interest rate environment is causing developers to, I would say, slow back on new development, but we expect activity to pick up with falling interest rates. Asset quality remains strong. NPLs dropping quarter-on-quarter, and there is a good split between different types of development projects, where residential is over 50% of the construction portfolio. Flipping over to the liability side of things. As before, deposits make up the most of our liability side or over 51% end of the third quarter. There has been considerable growth in deposits, as Jón Guðni stated before. And the deposit base is over 50% from retail customers. Retail, for example, grew by 3.9% during the third quarter. Loans to deposits or deposit to loans closed off at 137% or 116% if we exclude mortgages, which are funded by CPI -- by covered bonds, sorry, as we fund our mortgage operation through covered bonds to some degree. There is little concentration in the deposit base, which remains stable on our balance sheet.



The wholesale funding base is quite light at the moment. End of Q2, the bank tendered for any or all of its EUR 300 million bond and got a 91% take-up. Beginning of July, we issued or we exercised our right to buy the remaining amount. So, we have quite low contractual maturity profile on our borrowings for the next 2 years or so. We have seen the international spreads coming down over the past few months. But recently, they have been moving sideways and are still a bit wider than what we see from comparable banks internationally in terms of rating and size. Domestic funding operation has been going well and is providing us with good opportunities to diversify our funding base, both domestically as well as internationally.



Liquidity as a result, is quite strong and considerably in excess of regulatory requirements. We closed off the quarter with LCR of 223%, where the ISK position is at 154%. Net stable funding ratio is also quite significantly in excess of regulatory requirements. The liquidity book is currently around 20% of our assets as it has been for the last few quarters, mainly invested in good quality assets. As before, there are no unrealized losses on the book itself. Everything has gone through the balance sheet. And lastly, capital. The bank closed off at 23.4% compared to a regulatory requirement of 19.7%. We have stated that we want to have a management buffer of 100 to 300 basis points. So, assuming the mid position of the management buffer, the bank is roughly 280 basis points ahead in terms of CET1. That leaves us with excess capital from a CET1 position of around ISK 28 billion. In addition, the bank has deducted from the capital base capital, which is being used for buybacks, of which 6 billion.



Further, we are a standardized bank, as you can see on the high REA ratio as well as the leverage ratio. Due to that, implementation of CRR3, which is expected to take place early 2025, is expected to provide us with capital relief as the bank expects the risk-weight amount to reduce by about 4%, providing us with further capital uplift and potential distribution. As before, we have stated that we aim to optimize the capital position before year-end 2025, subject to market conditions, which may take place through growth, both organic as well as external, or through distributions to shareholders through buybacks, reverse auctions and/or extraordinary dividends as the bank sees fit during the year. With that, over to you again, Jón Guðni.

[Jon Guoni Omarsson, executive]

Thank you, Ellert. As we noted, we are obviously very happy with the first 9 months of the year, and especially the third quarter. The bank remains extremely well placed in terms of the balance sheet quality and especially on the capital side. In terms of our earnings, obviously very strong in the third quarter, but we remain cautious and conservative in terms of our guidance for the year as a whole and expect to be at around 10% due to this volatility in the interest rate environment. Impairments obviously having an impact as well on the earnings, impairments which are inherently a bit difficult to predict. But the outlook, as you have seen from our asset quality, the outlook for the coming months is quite strong at the moment. As an audit, strong balance sheet and capital position, and that makes us obviously, very well placed to enjoy the spring in the capital markets and the following summer. Then I think we should move over to you, Bjarney, for the questions.

[BjarÂney BjarÂnadotÂtir, executive]

Thank you, Jón Guðni. Now we open up for a Q&A session. [Operator Instructions]. So, operator, are there any questions on the line?

[Operator]

There are none at the moment, but we'll wait a second and see. [Operator Instructions]. The first question comes from the line of Piers Brown.

[Piers Brown, analyst]

I had 2 questions. The first was on the net interest income and just the impact of the CPI imbalance. So, I mean, you've talked about ticks and your expectation that the ticks in the fourth quarter will be lower than in the third quarter. Does that mean that the CPI contribution to interest income is still positive, but just at a lower level? Or does it mean that it's a net negative contribution? That's the first question. And then the second question is just on the elections and the impact on the government stake sell-down. Is there a scenario formation of the new government whereby the sell-down wouldn't happen? Or is it simply a timing issue and a delay to the process?

[Jon Guoni Omarsson, executive]

Thank you, Piers, for the question. I'll start with the second one. It's obviously a bit difficult to predict in terms of politicians what exactly what they will decide. But from my discussions that I've had with the politicians and what we hear in the news, I believe that most parties agree that they should continue the sale to obviously, to use the proceeds to build up infrastructure and pay down government debt. So, I'm at least I'm optimistic that when the new government has been formed that this will be close to front of their agenda. And especially since obviously, preparations have been ongoing, the government has incurred some costs for the preparations to have everything ready. And so, yes, it's difficult to predict, but I'm optimistic. And then over to you, Ellert, for the second question.

[Ellert Hlodversson, executive]

Yes. In terms of the NII, obviously, we accounted for in the third quarter, inflationary ticks of 1.04%. As we state, we are expecting 0.36% to be an inflationary tick box over the fourth quarter. We have already one measurement in place, which was the September measurement, which was actually a deflation of 0.24%. But assuming the Iceland or Ãslandsbanki Research macroeconomics to -- I would say, to materialize, we expect the fourth quarter to account for, as I said, 0.36%. Our imbalance end of the quarter is at 215 billion on the group level. So, it's a matter of a viewpoint. If you view this as, I would say, loss of income or if you view this as a net loss for the -- I would say, for the portfolio, for the CPI portfolio. Obviously, the reason why we have CPI imbalance is that our balance sheet is not in balance, if you will. Our balance sheet is not at balance. So, we are funding the CPI-linked loans to some degree with nominal loans. Probably the easiest way to think about this is reducing interest income really, while the interest expense line has more to do with policy rates through rate cuts and deposits, if that comes to your question. So, I think that's probably the easiest way to think about this.

[BjarÂney BjarÂnadotÂtir, executive]

Are there any additional questions on the line?

[Operator]

No more questions at this time.

[BjarÂney BjarÂnadotÂtir, executive]

No. And there are no written questions being submitted. So, if there are no further questions, we thank you for joining us this Thursday morning. We appreciate the time you spent hearing these guys out, and I hope you have a good day.