Islandsbanki hf

ICEX:ISB

Earnings Call Analysis

Islandsbanki Reports Solid 2023 Performance

Islandsbanki experienced an eventful 2023 with seismic activity affecting the local community but still achieved strong financial results. The bank's return on equity (ROE) was 11.2% for the fourth quarter, despite ISK 1.7 billion in impairments due to the seismic events. The full year's ROE surpassed the 10% target, cost-to-income ratio was well below the 45% threshold at 41.6%, and a proposed dividend and a share buyback program of ISK 10 billion were highlights. Economists forecast modest growth for Iceland’s economy, and Islandsbanki expects ROE around 10% for the next year amid modest economic growth and ongoing uncertainties, such as from inflation imbalances. The digital front and business banking performed well with significant growth seen in digital sales and corporate services.

Islandsbanki's 2023 Eventful Journey Amidst Challenging Times

In a year marked by internal shifts and external hurdles like seismic activities in the Reykjanes peninsula, Islandsbanki navigated through with a robust performance. Despite earthquakes and eruptions impacting local communities and causing impairment charges, the bank delivered a return on equity (ROE) of 11.2% for the quarter and a commendable 12% for the year. Excluding the impairments, ROE could have hit 13.4% for Q4 and was bolstered by an active business banking sector boasting a 40% market share and substantial growth in digital sales and corporate banking services.

Facing Uncertainty with Measured Optimism

The bank's guidance for the year reflected a realistic outlook, setting a target ROE of around 10%, based on expected through-the-cycle impairments. Despite concerns over net interest income fluctuations and impairment impacts due to the ongoing geological disturbances, the mood remained positive. The bank foresaw modest economic growth and potential tourism sector impacts, but Icelandic industries continued to thrive, with the construction sector moving steadfastly forward.

Financial Fortitude Amidst Softening Fees and Market Volatility

2023, a turbulent year for markets, saw Islandsbanki report a 9.9% growth in core income. Fee-based revenues saw some strain, especially in asset management, due to volatile conditions, although recovery signs emerged towards year-end. The digital thrust continued, with the roll-out of new online banking solutions and a successful digital onboarding initiative, asserting the bank's commitment to technological leadership and service enhancement.

Strategic Moves and Strong Credit Performance Fortify Stability

Islandsbanki prioritized maintaining a healthy cost-to-income ratio, ending the year at 41.6%. The bank witnessed a 13.6% increase in operating expenses attributed mainly to wage inflation. Credit quality remained solid as loan portfolios diversified and sustained, with a significant portion tied to mortgages. Moreover, the bank showed prudence by proactively reallocating loans due to the Reykjanes seismic events to higher risk stages, reflecting a deliberate and conservative risk approach.

Operational Resilience and Future-Ready Capital Strategies

The bank concluded the year with a strong capital position, exhibiting an equity ratio of 25.3% and proposing a dividend payment of 12.3%, representing 50% of the year's profit. Islandsbanki also outlined plans to optimize its capital structure before 2025, initiating buybacks and considering future avenues for capital deployment. With a clear vision, the bank set forth in 2023, equipped to capitalize on growth opportunities while upholding its commitment to shareholder returns.

Earnings Call Transcript 2023-Q4

[BjarÂney BjarÂnadotÂtir, executive]

Good morning, and welcome to Islandsbanki's Friday, where we present the fourth quarter and full year results of Islandsbanki. I'm Bjar-ney Anna with Investor Relations, and I'm joined today by our CEO, Jón Gudni Ómarsson; our new CFO, Ellert Hlodversson. Before I hand the session over to them, I wanted to mention that as per usual, we will have a Q&A following the presentation. 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 through the platform or send an e-mail to [e-mail]. Guys, over to you.

[Jon Guoni Omarsson, executive]

Thank you, Bjar-ney, and good morning to you all, and thank you for joining this call on our full year results for 2023. Islandsbanki had quite an eventful year in 2023. During the middle of the year, we had some internal changes. But then in the latter half, our attention was moved to the external environment and especially the seismic activity on the Reykjanes peninsula, where we have had quite a few earthquakes and eruptions almost monthly now for the past few months. This has had an impact on the small town of Grindavík with just over 3,000 inhabitants. And earlier this week, we had an eruption actually, which had an impact on the hot water supply to a bigger community of about 30,000 people on the peninsula. But that's hopefully something that will be fixed in the next couple of days to bring their life back to normal for those inhabitants.

This obviously impacts a bit our results. We had a very good quarter with 11.2% return on equity, having taken into account ISK 1.7 billion of impairments due to the activity in the Reykjanes peninsula. Without that impact, we would have had around 13.4% ROE in the fourth quarter and just over 12% ROE for the year as a whole. As you can see, we have increased a bit our Stage 2 loans as a result of this as well. But overall, our asset quality remains very robust.

In terms of our financial targets, we reached all our targets in the year 2023, obviously, with a return on equity well above the 10% target and the cost-to-income ratio well below the 45% target for the year as a whole at 41.6%. The equity ratios remain very well above our requirements and also our internal targets, and Ellert will take you through that a bit later on. We are proposing a dividend of 50% of earnings, and we are also planning for a buyback program of about ISK 10 billion.

Our guidance for the year in terms of return on equity is to be around 10%, assuming through-the-cycle impairments. There is some uncertainty regarding the net interest income item, especially due to a larger inflation imbalance and the impact of inflation and the real rates in the coming few months. At the same time, there is some uncertainty regarding the impairment account as well due to the volcanic activity, but the outlook remains quite good. And like we said, we are expecting around 10% return on equity assuming through-the-cycle impairments.

In terms of the economy, our economists are expecting a fairly modest growth this year. We will obviously see what the impact will be on tourism from the recent activity in Reykjanes. But overall, the outlook is very good. And the industries in Iceland, in general, are doing very well. We are seeing the construction sector keeping on a fairly good pace in spite of the quite high interest rate environment. And obviously, Iceland is quite low levered, which helps in this environment, especially with the higher rates.

In terms of monetary policy, we have just recently had quite a low print in terms of inflation. So there is some encouragement there, and some increased expectations that inflation will be coming down fairly quickly and that we can have a reduction of interest rates in the middle of the year and possibly even earlier than that.

In terms of the year as a whole, like I said, it's been an extremely eventful year. We had positive movements from both Moody's and S&P in terms of our ratings. And all business units did quite well. We have seen, obviously, a very strong market share in the SME sector. Our chatbot, Fróði, has increased servicing more and more of our individuals directly and without human involvement. And so we're seeing very good progress on that front.

We have been leading in FX sales and also have been extremely busy on many fronts in terms of advisory. And for example, we have had a very good start of the year in terms of equity progress.

Moving then over to a special attention on business banking, which had a very good year last year, had about ISK 120 billion of new loans and about 19% return on equity, and also seen a good growth in deposits. Our car leasing arm called Ergo, which is a part of our business banking unit, had a record year, some 20% increase in loans and a lot of activity in terms of loans to car rentals especially, which had quite a big growth in their car fleet during the year. So overall, a very good year for business banking, which enjoys a market share of around 40% in Iceland.

On the digital front, we have seen quite a few wins and obviously continue to invest quite heavily on that front. The numbers speak for themselves. We are seeing digital sales continue to increase. And we have been investing on our data journey quite heavily and will continue to do so this year. We will be bringing a new online bank for corporate life this year as well. And earlier this week, we managed actually to launch corporate onboarding, fully digital, for corporates here in Iceland. And already in the past couple of days seeing a very strong pickup from there. So overall, a lot of things happening on the digital front all over.

In terms of sustainability, we continue to be quite focused there and have high ambitions on that front. We have now risk categorized 93% of our corporate credits. And we have been meeting with our clients, both on the lending front and also our suppliers and pushing them obviously to enhance on this front and do even better than before. I believe the dust is settling a bit on sustainability in terms of information sharing, and we obviously have in our accounts and in the annual sustainability report, a lot of information about what the bank is doing on that front.

And we have now measured obviously, our loan book already in terms of where we see the carbon footprint. And our focus will now move towards where we can actually make a difference. And what we see is that the biggest impact factor there is in terms of transportation. So we'll look into that and see how we can work with our clients on that front. We also updated our sustainable funding framework late last year. And earlier this year, we issued our first issuance under the new framework, where we did the issues in Swedish krona and Norwegian, which was very well received by international investors.

So overall, very good results. And obviously, we'll open up for questions a bit later on. But I want to hand it over to Ellert, who will take you through the financials. Thank you.

[Ellert Hlodversson, executive]

Thank you, Jón Gudni. Overall, we're quite happy to present the results we have here for the fourth quarter and the full year results for 2023. Core income in the last year grew by 9.9%. At the same time, as Jón Gudni mentioned, impairments came up as we saw Grindavik turning into an uncertainty, and we'll dig into that in more details.

Return on equity for the quarter amounted to 11.2%, but should have been 13.4% if adjusted for the inflation -- impairment, sorry. We've got to change the slide, apologies. For the full year, return on equity was 11.3% compared to 12.1%. In parallel to our annual accounts, we have released various risk reports, Pillar 3 report and other material, which we direct investors to look at.

Turning our focus into the net interest income. We are seeing a bit softening on net interest income in Q4 compared to Q3. That is mainly on the back of higher Central Bank reserves and loss related to the CPI imbalance as Jón Gudni alluded to. NIM margins, looking on the lower left-hand side, reduced in the second half of the year from 3.2% in the first half to 2.9%. During the fourth quarter, policy rates remained unchanged at 9.25%. Inflation, however, was subsiding.

On Wednesday, the Central Bank announced the rate decision where policy rates were kept unchanged still. Inflation ticks end of last year in November and December were 0.4% compared to a minus 0.16% in January, which is below analyst consensus. Throughout this year, we are forecasting that inflation will continue to subside and be approximately 5.2% on average on this year. Policy rates are forecasted to follow. However, as the loan portfolio has shifted towards a more CPI -- to more CPI-linked loan instruments, NIM is expected to become more volatile and pressured given, I would say, the coherence between the nominal rates and the inflation, how that pans out over the coming months.

Turning our focus into fees. Q-to-Q, net fee and commission subsided a bit as volatile market conditions affected asset management. However, markets are starting to recover towards the end of last year and the beginning of this. So outlook is positive. Cards and Payment Processing was a big contributor to net fee and commission income in the last year. We saw a decline in Q4, partly related to an expense, which, to some extent, should have been reflected in the full year figures. So we need to view this as a whole throughout the year. Allianz, as last year, as in 2022, was a good contributor to net fee and commission income. Overall, we're happy with the fee generation in turbulent markets.

We saw positive turnaround in financial income towards the end of the year as markets started to recover. Main contributor there is an appreciation of the liquidity portfolio as market rates are coming down. During this quarter, the bank has reclassified its bond position in the liquidity portfolio to a nontrading book from a trading book. This reclassification was approved by the Central Bank and resulted in less market risk and capital requirements in CRR.

We have undertaken limited market risk exposure this quarter as previous quarters, as can be seen on the right-hand side of the slide, segregated between equities and bonds. The cost-to-income ratio in Q4 was 42.7%, which is within the cost-to-income ratio target of below 35%. However, comparison to Q3 will need to take into account seasonality mainly related to salaries, as salaries are accrued throughout the year.

Looking at 2023 as a whole, OpEx rose by 13.6%, mainly on the back of general wage increase and inflation. Calculating the cost-to-income ratio, we are eliminating the administrative fine both in Q4 2022 as well as in Q2 2022 -- sorry, Q4 2023 and Q2 2022 to provide a better going concern cost-to-income ratio comparison. As a result, the cost-to-income ratio in 2023 was 41.6%, which is flat from 2022 on the back of stronger revenue generation, which offset the cost increases incurred through the year.

Overall, we feel that cost is well maintained within the bank, and we are confident that we will continue to be within targets in the coming quarters. Then into the balance sheet. Loans to customers closed off at 1,223 billion end of last year, growing by 3% year for year. Business banking was contributing the most, while we saw a slight deduction in corporate investment banking, both in line with our expectations. Overall loan book portfolio was well diversified where mortgages account for roughly 40% of the portfolio. We have seen a slight pickup in construction, as Jón Gudni said, and we'll dig into that later on in the presentation.

Credit quality remains good, and I draw your attention to the lower right-hand side graph indicating the segregation between risk classes. This is reflecting on the bank's rigorous risk culture and robust management practices. Year-end LTVs closed off at 57%, down 1 percentage point from last year. Impairments is the other side of the loan book. And credit quality remains strong, looking at it from an impairment standpoint.

Starting off with forbearance. We see loans in forbearance subsiding throughout the quarters as loans related to COVID went out of the 24-month period. Stage 3 loans remained flat throughout the last year at 1.8%, while we see an increase in Stage 2 related to the seismic activity in the Reykjanes peninsula. The bank has moved all its exposures with direct relations to Grindavík to Stage 2, which reflects the major change there, too.

As everyone is aware, and Jón Gudni stated before, there is a lot of uncertainty in the Reykjanes area. So as a result, we have made some management overlays to the impairment model. In the last quarter, we did a management overlay of ISK 1.7 billion, taking into account this uncertainty. The overall exposure to Grindavik is limited, roughly 0.4% of loans to customers. However, we can see from an impairment standpoint, should we have not impaired this additional ISK 1.7 billion, impairment reversals would have occurred on Q4.

For the whole year, the cost of risk amounted to 8 basis points compared to 33 basis points in Q3 on an annualized basis given this management overlay. Digging further into the mortgage book, we can see the Stage 2 increase on the lower right-hand side also related primarily to Grindavik. LTV for the entire book is 57% end of year, down 3 percentage points from last year. On the top left side, we can see how the loan book is segregated between various loan products. There we can clearly see the shift from nominal rate loans to either fixed or floating CPI-linked loans, as we have previously stated. This can be viewed as borrowers taking control on the financial health and manage their monthly payments through the high interest rate environment.

During the year, ISK 38 billion are subject to rate refresh from fixed rate mortgages nominal. Next year, this amounts to ISK 56 billion. As inflation goes down and policy rates follow, we believe that this will pave the way for these loans coming to rate we set to be refinanced into various other loan products. Real estate and construction sector in Iceland is in good shape. If we start with the real estate exposure, this amounts to 12% of our loan book end of year. These are primarily CPI-linked loans on the back of CPI-linked lease agreements those companies have with their clients, providing a natural hedge within their operation.

Construction exposure has been growing slightly over the last year, where we can see off-balance liabilities turning into on-balance liabilities, reflecting how construction is taking place. Overall, 50% roughly of our construction is related to residential construction compared to the other half through various sectors, as shown on the lower right-hand side.

And then off to liabilities. Deposits remain the largest funding source of the bank of around 46% of our entire funding need end of year. Depositor concentration is limited. The 10 largest depositors owned 10% of the deposit base. And a lot of this is within high liquid assets. We can see on the lower right-hand side that we have the largest depositors from individuals. Loans to customers closed off at -- sorry, customer deposits to customer loans closed off at 144% last year, down from 150% the year before.

Looking at debt issuances. During last year, we were happy to receive our A3 issuer rating by Moody's as well as a rate increase from S&P from an A to an A+ last November. Maturity profile in 2024 is limited. The following years, the repayment schedule is also quite healthy. This year, our $500 million Tier 2 SEK bond is eligible for call, which we suspect subject to market condition will be called and refinanced with a second Tier 2 instrument.

Further, we will remain a regular issuer of domestic covered bonds, although in smaller numbers than last year. In the senior space, we will remain adaptive with regards to timing, spreads and currencies. Liquidity is strong within the bank, close enough at 195% in total LCR and 115% in ISK LCR. The liquidity portfolio year-end amounted to 371 -- sorry, ISK 313 billion, which is roughly 20% of our asset base. Much of that is within level 1 assets. NSFR has remained stable throughout the year in the total numbers.

Lastly, turning our focus into capital. As Jón Gudni stated, year end, the equity ratio amounted to 25.3% compared to a regulatory requirement of 19.8%. Taking into account the increase in countercyclical buffer this March, the regulatory requirement will turn into 20.3%. At the same time, our MREL requirement closed off at 30.2%, while our ratio was 1,100 basis points in excess at 41.3%. Overall, our CET excess capital amounted to 620 basis points, and the total capital of 560 basis points.

Given the management buffer current of 100 to 300 basis points, assuming the midpoint of that and our optimal capital structure, we have the ability to pay out ISK 36 billion from our excess capital accounts. We will, in our next Annual General Meeting in March, announce a dividend payment of 12.3%, which reflects 50% of last year's profit in line with our dividend policy. Further, we will distribute the CET1 capital amounting to ISK 10 billion through buybacks.

Lastly, the bank aims to optimize its capital structure before year-end 2025, subject to market conditions. Overall, I can say that we are happy with the results we are presenting here today. Revenue generation was strong in 2023. Return on equity was good and related to core operations. The credit quality remains strong, as in previous quarters, reflecting on a cautious view taken on impairments. Lastly, our liquidity and capital positions are solid.

With that, I pass the floor again to Jón Gudni.

[Jon Guoni Omarsson, executive]

Thank you. And over to you, Bjarney, in terms of questions.

[BjarÂney BjarÂnadotÂtir, executive]

Thank you, guys. We'll now open up for a Q&A session. You can participate in the session via the conference call button or the platform, 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] The next question comes from Sofie Peterzens from JPMorgan.

[Sofie Peterzens, analyst]

This is Sofie from JPMorgan. So just maybe a follow-up on the last point that you made in the slide that Islandsbanki plans to optimize its capital structure before year-end 2025. Considering that you have over 600 basis points of excess capital, I know you want to do the ISK 10 billion share buyback this year, but how should we think about capital optimization? What will it entail? And yes, basically, what are the different tools that you could use?

And then my second question would be, if you could just elaborate a little bit more on net interest income outlook. I think you mentioned that it should be quite volatile given the link between the nominal rate and the inflation for the CPI-linked mortgages. But when we kind of model net interest income for this portfolio, how should we think about the moving parts? And how will the inflation kind of embark that, yes, the net interest income and maybe rate sensitivity and inflation sensitivity if you have it. That will be all for me.

[Ellert Hlodversson, executive]

Yes. I will start off with the net interest income. What we have seen in the last year is a shift in the market or in the portfolio where we have seen basically the composition change where nominal rates went down by ISK 42 billion, FX went down by ISK 44 billion, while CPI-linked loan instruments went up ISK 128 billion. If we take into account, I would say, the funding sources, where a large part of it, as we stated before, is deposit-based, which are primarily nominally denominated accounts. As a result, if we are seeing inflation subside, the inflation tick accounted for month by month will be subject to citing inflation and primarily fixed mortgage rates or fixed real rates, which will then reflect into a more volatility if we assume that the policy rates lag to some extent behind.

[Jon Guoni Omarsson, executive]

Yes. So in terms of the capital structure, we have obviously seen an improvement there, both on back of our earnings -- so in terms of the excess capital, both in terms of our earnings, but also in terms of REA optimization. So we've made some measures there and seen quite a bit of benefit. So the excess capital is obviously quite substantial. It's over 600 basis points in CET1. And if we take into account our management buffer, as Ellert mentioned earlier, it's around ISK 35 billion, the excess capital. As we noted, we will start with a buyback program of ISK 10 billion, and we will obviously contact that possibly mostly through the open market purchases. We will also then be looking into all the possibilities. We can obviously have an additional dividend payment or find other ways for buyback programs.

We could also issue a Tier 1 paper if we see the market there being constructive. And like I said, so at least we have the plan to start with the first ISK 10 billion, and then we'll see how the markets develop. And lastly, obviously, we could see some of it basically coming through growth in our loan book and asset growth. But I think the outlook there actually seems to be rather modest at the moment. Obviously, with rather high interest rates, we expect to see, yes, not too high lending growth, at least in the coming few months.

But then obviously, we'll see, as the interest rates come down, hopefully, later in the year, that lending growth could pick up in the second half. So overall, obviously, we have now -- it's towards the end of last year that we hope to optimize the capital structure and starting with the ISK 10 billion in buybacks for the next few months.

[Operator]

The next question comes from Piers Brown from HSBC.

[Piers Brown, analyst]

Just 2 questions for me. One is on the ISK 1.7 billion impairment you've taken for the seismic issues in Iceland. I wonder if you can just give us some color on that, I mean, how precautionary is that impairment? And is there a -- it sounds from the statement as if you're just being super cautious and that the actual exposures against which that's been booked are quite small. So if you could just give us some color on the prospect of that impairment being reversed as we go forward if the seismic situation settles down?

And then the second question is on the sort of size of the buyback, the $10 billion. Can you just give us a little bit of insight as to your thinking around how you calibrate the size of the buyback? Is it primarily with a view to liquidity of the shares in the Icelandic market? Or what are the factors are you thinking about when you calibrate the size of the annual repurchase program?

[Jon Guoni Omarsson, executive]

Yes. Thank you, Piers. If I start with the buyback, so ISK 10 billion, so we are seeing basically based on the liquidity in the Icelandic market and we can buy on a monthly basis of around maybe ISK 700 million -- ISK 700 million, ISK 800 million, and that equates to then close to ISK 10 billion for the full year, basically with the open market purchases. And we think it's just a good start to start with ISK 10 billion. And then obviously, we'll see how the year progresses on that front. Ellert, maybe a bit on the...

[Ellert Hlodversson, executive]

Sure. The ISK 1.7 billion on the impairments related to the Reykjanes peninsula is basically a management overlay. We have always been and remain cautious in our impairment assessment. We believe that our portfolio is strong. It has a strong security. It is a limited exposure. But from a cautious view, we thought this was the right figure to take into account at this point in time. The uncertainty is high, and we have seen volcanic eruptions, 2 of them actually in January and now in February, which are causing difficulties in the Reykjanes area, the last one pulling apart the hot water supply to the entirety of the Reykjanes area. So we feel that this is a cautious view. Of course, we hope that things pan out in a secure and successful manner. But Yes, this was the approach now.

[Operator]

[Operator Instructions] There are no more questions at this time. So I hand the conference back to the speakers for any written questions and closing comments.

[BjarÂney BjarÂnadotÂtir, executive]

Thank you. We have a question here on the platform from Jóhann Gísli Jóhannesson. He asks, can you comment on how you see the loan book development going into the year and break down the difference between corporates and individuals in terms of growth opportunities.

[Jon Guoni Omarsson, executive]

Yes. Thank you, Bjarney. I think there's a bit of uncertainty now in terms of the loan book growth. It depends on the business environment, obviously, both in terms of the seismic activity in Reykjanes and how that will impact tourism, and also on the interest rate environment. So based on where things stand at the moment, we expect to see, I would say, modest growth in terms of corporate lending, both in terms of SMEs and large corporate as well.

And when I say modest, I basically expect to see something in line with the nominal GDP growth. And on the market side, I would expect something similar. There is, however, when -- now a lot of customers are moving into inflation-linked products. It's possible that we will see some pickup in market share from the pension funds. So it's quite likely that actually we'll see some shift into these pension funds on that front. So overall, I would say it's a reasonable and rather modest growth that we are expecting over the next few months, at least.

[BjarÂney BjarÂnadotÂtir, executive]

As there appear to be no further questions, we want to thank you for joining us this morning. We appreciate all of you attending and raising the questions, and your commitment to joining our webcast this Friday morning. Have a good weekend.