Arion banki hf.

Hello everyone and welcome to this investor presentation of Ariane's first quarter results of 2020. My name is Benedikt Gislason, I'm the CEO of Ariane. With me here today going through the presentation will be Stefan Pedersen, CFO, and Egge Tetson, Deputy CFO. This first quarter was certainly an unusual one. a stress test to our operations in many ways, and very much impacted by the COVID-19 pandemic. It's very pleasant to be living in a country like Iceland, where authorities and healthcare system coped extremely well with the situation, as I'll explain in the next slide. However, obviously, as everywhere else, this is going to impact the economy And we are reliant on tourist industry, for example, and that is going to impact our economy this year. And we have been very focused throughout this period to ensure that we operate our business seamlessly throughout this period with a majority of our employees working from home since 12th of March. And at the same time, service our clients in dire times when they really need us. And we have successfully been able to support our customers, both individuals and corporates. And as I explained in the press release, we have already taken measures of repayment holidays for households of 11% and corporates of 9% of the portfolio. So an average 10% of our loan portfolio is currently in temporary repayment holiday. But it's also very pleasant to see that we were able to continue our sort of restructuring or operational improvement of the bank. And I think it's fair to state that the core operations are continuing to improve, as Stefan will explain later on. And at the same time, we were preparing to complete the formal sort of complete normalization of our capital structure and issued additional tier one instrument in the first quarter. And we're planning to pay a meaningful dividend despite sort of low profitability last year, all part of normalizing the capital structure. This has been put on hold. And that means that we have an extremely strong capital position of 27 and a half percent. And around one third of our equity is now in excess of regulatory requirement, which is very unusual. Now going to the COVID-19, as I told you previously, Iceland has navigated extremely well through this pandemic. We have tested already around 15% of the population, and we've been very efficient in contact tracing. And one of the first countries to release, so this was a manual work before, and now we have released a app that enables authorities in collaboration with the general public to digitally do the contact tracing, which means that we will be in a good position to deal with the second wave if that materializes. But it's very pleasant to see the numbers coming out of Iceland despite the heavy testing. For the last three days, we have not seen any new infections. And we were able to flatten the curve. And our health care system coped well. We beefed up capacity. And our hospitals are well equipped to deal with any kind of new infections that might come out of the reopening of the economy, which is already started and we're seeing major or large steps taken later this month. Now, obviously, COVID-19 is impacting our economy. It's like everywhere else. And here we have a GDP forecast from the IMF, which demonstrates a V-shaped recovery. I guess many economists are, in sort of recent weeks, starting to believe that it's not going to be as strong V-shaped recovery as one hoped for. And we might see a... sort of a longer downturn and a more gradual recovery on the back of this. Iceland is impacted in many ways. Our export industries are impacted, and we are very reliant on export industries. It comprises between 35% and 40% of our GDP. And tourist industries is around 8%. And the current estimates are that we will see at least 60% contraction in number of visitors to Iceland. That includes, obviously, a normal first two months of the year, which means that the contraction is even greater throughout the year. And GDP is going to be impacted. and our currency has weakened, but still we are enjoyed with a fairly high GDP per capita of $45,000, which compares well with the other Nordic countries. Unprecedented times. And unemployment rate is shooting up. The authorities have taken similar measures elsewhere when it comes to unemployment rate and also offering to compensate for a reduced employment ratio. And that means that currently, through our unemployment scheme, Around 17% of the working population is now compensated either fully or partially through that scheme. And this the authorities can do with a very strong sort of balance sheet, low debt to GDP ratio of 30%. And this is helping companies to navigate through a sudden stop scenario where revenues, in some instances, are virtually dropped to zero. And there are obviously commitments that you need to honor. This has impacted our exchange rate. To a lesser extent, inflation. There are some deflationary forces that are sort of bringing inflation down, like oil price. and other things and we've seen clear indication that private consumption is coming down. But what is important to note around our economy is that even though we have tourists spending 500 billion krona last year in Iceland, Icelanders like to travel as well and last year Iceland has spent 350 billion abroad. So the travel restrictions obviously work both ways, which means that we will see the local tourist industry flourish this year. So there's clearly going to be mitigating factors to the contraction in sort of foreign tourists coming to the country. Like I said earlier, the fiscal budget, fiscal balance is, we've been running a fiscal surplus for the last few years, which has brought the debt to GDP ratio of the Icelandic treasury to one of the lowest levels in Europe. And at the same time, and this is something that I think the The financial crisis in 2008 very much influenced households and corporates to be more prudent with their financial matters. So you can see from the top right-hand graph that leverage in the system, borrowings of households and corporates are historically quite low and actually in international context as well. The key interest rates have been moved, lowered quite dramatically. But still at the high level, there is room to lower those further. And that is definitely going to impact our net interest income. And Stefan will explain that better later on. But what is very sort of comforting to see is that despite contraction in export, the corona has... It's weakened, but it's not taken the dive that it usually takes when we have financial or economic downturn and financial sort of dire situation. And that is obviously because we have throughout the years, for example, through a national savings rate accumulated of 60% over the last seven years. built up a massive FX reserve, which the central bank is now using to stabilise the corona. Now Treasury, Icelandic government and central bank have been able to respond to the COVID-19 situation quite strongly using their balance sheets. And measures taken towards the banking systems are very similar to those seen elsewhere. I would say a larger step has been taken in terms of the taxation, where the bank levy was, in one instance, moved to the level that Treasury was targeting in three years' time. And that is benefiting our sort of income statement this year by at least $1.6 billion. and is a mitigating factor against pressure on net interest income from lowering of the key policy rates. And then the government is using its balance sheet, and we expect the sort of government guarantee lending scheme to be rolled out in the next few days or weeks. And we're one of the banks that participate in that program. Now, I talked earlier about the business continuity. We initiated that effectively in late February. By the 12th of March, we had to let or ask most of our employees to work from home to comply with the guidance from the health officials in Iceland. And so we closed most of our branches. We are now reopening them, but with a new branch network structure in place, shortening opening hours, merging branches. And one really good thing about this is that our large investments into digital services really paid off through this and we saw a massive rise in sort of digital channels being used by our clients and we were able to service them seamlessly throughout this period and used our call center to provide technical services to clients that were not used to these digital services. I've talked about solutions for individuals and customers, and we will continue to provide support where needed. We have, however, not changed our lending criteria or lending standards in any way. But it's clear from the sort of financial health of our clients that many of them are in a position to borrow more or defer payments because of low level of debt. And there we are happy to provide more credit. Before going into the financials, I want to end my presentation by going briefly through Valetor, which is a subsidiary that we've owned and have had in a sales process for a number of quarters. And it's clear that investors and analysts will be prompting us with questions about where we are with that process. And I just want to, because Valetor currently is going through a quite a large restructuring of its operations, which were inevitable. And I think one of the learning points from the sales process is that some of the expansion, international expansion that Valetor went on was unsustainable, unprofitable, and did not gain the same attraction as we hoped for in terms of investor appetite. And in this slide, it explains the sort of the strategy that was put on or sort of laid down in late 2014 when Arjon bought a minority stake from Landsbanki and became the sole owner of Alator. And then it was a strategic decision to go into a business that Violator had not previously been directly involved in, which was direct channel services abroad. Obviously, Violator has very well established operations in Iceland in that field, but did not have the market experience or sales channels or... to sort of do that and a part of that journey was to invest into three companies and build up the operations out of Denmark and in the UK and sadly to say this has not been a successful journey and we are now taking and scaling it back and cutting our losses And the losses are steep. In addition to the four billion of right and of goodwill, which is directly connected to the direct channel investment, the most of our valid accumulated losses over the last four years can be related to this investment. We're confident in the new management of Valetør. We made some changes to the board as well that we will see Valetør thrive going forward based on a business model that is much more a reflection of a previous business model which made Valetør a very profitable company. And obviously our sales efforts continue. We do not see us as a key owner of the company. But this restructuring will enable us to hopefully divest the asset sooner rather than later. And now I'll hand over to Stefan Peterson, who will go through the financials.

Thank you, Benedict. And good morning, everybody. First, just a few highlights from the first quarter. We have gone through a strategic review or did that last fall, and we are continuing to see that yielding results in core operations, both on the revenue and cost side. However, as Bente said, COVID-19 has a fundamental impact on the results in this quarter, and I will go to that. Our balance sheet is exceptionally strong. Capital adequacy ratio of 27.5% is very prudent at the current time, but not sustainable in sort of a normalized environment. And as we have been focusing on deposits and want to increase sort of their importance in our funding mix, it's very good to report that they are at 9.4% from year end. Now, looking at the income statement, as I said, we are seeing positive trends in core revenues and OPEX. Interest income, commission income, and insurance income are trending up significantly. collectively, and we are seeing operating expenses down 10%, both salaries as well as other OPEX. So this is all positive. However, going into COVID-19, we see that having very strong impact on net financial income. It has obviously a very strong impact on net impairment, and I'll talk about both of those later on in the presentation. And it affects discontinued operations as well and push our earnings for the quarter into negative 1.2 billion from continuous operations and negative 2.2 billion from net loss. On the income side, we are pleased with the developments in net interest income. It is down 2% from the same quarter of last year, but interest bearing liabilities are down 5%. We have been able to push our net interest margin up 10 basis points in a very challenging environment. And when I say challenging, I say challenging because we are seeing the policy rates at historical lows. Inflation has been extremely low during the period, 1.1%. And since the first quarter of last year, we have changed our funding mix and issued both Tier 2 and 81, which is relatively expensive funding. What this means is that we have been doing... I would say, a good job on the lending side and on the funding side in general. This is also demonstrated by the slide there, by the chart there on the top right-hand side, where we are seeing our net insert income on average credit risk move up from the first quarter of last year, and this is something we focus on very heavily. It's actually good just to see the bridge there on the bottom of this slide. It shows how... NII has changed from the first quarter of last year. And as you see, in a lowering interest rate environment, we are receiving less revenues from the loans to credit institutions, less revenues from our loans to customers. But that is more than offset by... by less payments on securities, paying less for deposits, and way less on borrowings as well. And then, again, to increase our cost comes subordinated issuance. And there on the right, we see that the inflation effect compared to last year is negative by some 270 million. So all in all, we are happy with the development of our NIM. Obviously, we are focusing on this. As Brenda said, we are seeing or we believe that interest rates will continue to decline, at least over the near term. That will have a negative effect on net interest margins. Then at the same time, inflation is likely to increase somewhat from the current levels, which will have a positive impact. Fees and commissions are strong, as is insurance. The trend in fees and commission is especially strong in lending. This is in line with our strategy of increasing our capital velocity. Whether we will be able to continue on this growth is questionable. But we are focusing very much on increasing our fee business. And on the insurance side, our insurance company, Verder, has been doing extremely well. We are seeing their net insurance revenues almost doubling from the same period last year. And their combined ratio of 103% is, I would say, almost super strong in the first quarter of the year in Iceland. We took a hit on net financial income, negative by 2 billion. As we see there on the bottom right-hand side bar chart, this only has to do with negative impact on our equity holdings. Our equity holdings aren't that large, but we had a substantial negative impact at the end of the first quarter. Those holdings are both international and domestic. On the international side, the biggest part is what we have already disclosed. We hold preferred shares in Visa International. And on the local side or domestic side, this is a mix of a number of equity holdings that we have both listed and unlisted. The balance sheet, as I said before, it is very, very, very strong and in a way it's too strong. But that is an advantage at this period in time. We saw the balance sheet increase by almost 10% from year end, mainly in liquid assets. Clearly, we had some changes during the first quarter. We issued 81, and we had plans to pay dividends. That was postponed and actually canceled. So what we have now is we have loans to customers being close to 66% of our balance sheet. The rest is more or less liquid assets. And if we look at the loan book, We feel it's very well balanced. It's almost 50-50, corporates and individuals. And also if we look at the individual space, only around 7% of the loan book in total is consumer lending. Most of our individual lending is actually firstly in mortgages, highly centered around the Reykjavik area. We ended the quarter very liquid, which is also strong in today's world. Total LCR was 224%, and our liquidity in ISK was close to 160%, meaning that the bank is very well equipped to deal with the current economic downturn. Loans to customers. have not increased. They're relatively static from year end and actually have decreased in real terms. Because as we said, we are working to reduce the corporate loan book. We did reduce it in absolute terms. But given the decrease in the value of the ISK, as we do have corporate lending in foreign currency, that sort of kept static throughout the quarter. We took a 38 basis point impairment on our loans in the quarter. Thereof, 16 basis points had to do with changes in our economic scenarios in our IFRS 9 models. 11 basis points had to do with specific impairments in stage 3. Six basis points were relating to us sort of moving our tourism exposure from stage one to stage two. And then five basis points had to do with all the loan impairments. Now, I just want to stress that we should not think about this as as a continuous thing, i.e. we can take those 38 basis points and multiply by four and get the annual impairment. This is IFRS 9 accounting. This is our view of the loan book as it is now. And if we talk about that loan book a bit... It is very well collateralized. What we are showing you here is our exposures by sectors and the collateralization in each sector. And we can see that the loan book is very well collateralized. 91% actually, of which 70% are real estate assets. Obviously, mainly retail assets, but also commercial real estate of various forms. The sector where our collateralization is the lowest is actually in other corporates. But we should keep in mind that in this segment, we have large corporates with strong cash flows where we do have pari passu and negative pledge. And this is actually a sector that we are not overly concerned with. On the bottom, we are also showing the loss allowance or the sort of accumulated impairments in each sector over time. And I think it's interesting to show or see that if we look at the right-hand side where we have sort of pulled the travel, our travel exposures out of the sectors because travel isn't a sector according to ISAT. We have 94% collateralization there mainly in real estate of various sorts, hotels and so on. And then on the bottom, we have impaired almost 5% of this sector, meaning that our open position is actually very small. So we maintain that the balance sheet or the loan book is strong and well supported. And also just to show you how we have applied IFRS 9 during this quarter, then we can see on the left-hand side, on the total loan book, we are seeing an increase in stage two. That is not so much happening on the individual side, but looking at corporates, we are seeing a substantial increase in corporates from stage one to stage two. And obviously, as you can see there on the right-hand side, we have taken our travel exposures and we have fully pushed them into stage two. The liability side is very solid as well. A good funding mix between deposits that have increased. And then we have our wholesale funding where we do covered bonds in the domestic market and senior and secured in the international markets. We are in a very favorable position when it comes to sort of refinancing risk. As we don't have any maturities in foreign bonds this year, and sort of everything else being equal, we'll not have to go to the market until in the first or second quarter of next year. Own funds are particularly strong, as I said before. Capital adequacy ratio of 27.5%. And CET1 of 22.5%. The CET1 ratio is increasing because we cancelled our dividends of 10 billion that we had planned due to the pandemic and due to the request of the central bank. And we have filled up our buckets of both 81 and Tier 2. And all of these funds we intend to distribute to shareholders at the appropriate time. We are also pleased to report that even through this pandemic, we have been able to lower our risk exposure amounts slightly, 720 to 713, which we believe is relatively unique in today's world. And our leverage ratio is, again, very, very strong at 14.5%. As Bendis was saying in the outset, that the capital position is, in a way, super strong. Our requirements now are 21.9%, including our management buffer and actually including the counter-cyclical buffer, which was removed from 2% to zero due to COVID. We are still categorizing that as management buffer. So what we have is we have 5.5% surplus capital. that is 39 billion ISK, but that sits on top of a 24 billion ISK management buffer. So we have more than 8% buffer on top of our naked requirements. Again, we did postpone our dividend payments, and we will need to wait until we have more clarity on the COVID-19 pandemic before any decision can be made on further distributions. So looking forward, then we believe that macro developments will dominate both here in Iceland as well as globally. in the coming few quarters. We are in the process, and we will support our customers as practicable and possible. And we have the strength to work with both the customers as well as the government for the preservation and rebuild of the economy. We will obviously continue to focus on revenues and expenses. It's actually good to report that our leading position as regards digital services has already helped us. And I think it's fair to say that this recent experience will facilitate change in the way we do business. We are actually already seeing signs of that with changes in our branch network. I think it's fair to say that even if we are applying IFRS 9 now, as we do, sort of given the uncertainty, we cannot rule out that further impediments will take place over the coming quarters. But again, we should not assume that it's going to be 38 basis points times four. We should also not rule out the possibility because economic turbulence often yields possibilities. We should not rule out the possibility that we as a bank can use our very strong capital on opportunities that may be in the market. And finally, we continue to be committed to our medium term targets, but obviously assuming that the economy, global economy recovers in the medium term. Thank you.

So I guess we now put the control to the narrator who is collecting questions from the audience. I think we will start with the ones that are on the phone.

To ask a question, please press 01 on your telephone keypad. If you wish to withdraw a question, you may do so by pressing 02 to cancel. That is 01, if you would like to ask a question. Our first question is from Martin from Goldman Sachs. Please go ahead. Your line is open.

Yes, good morning. Thank you for the presentation, first of all. I have a number of questions. Would you like me to give them to you all now, or rather one by one as we go through?

Yeah, please just shoot all the questions now. We'll try and write them down. OK.

Okay, first here, I was wondering, some banks gave a cost of risk guidance or at least an indication from today's perspective whether we'd see cost of risk for the full year 2020. I heard your comment in the presentation that you wouldn't expect the first quarter level, which is around 150 basis points, to be continued for the whole year. Is there anything more precise you could give us in terms of range where, you know, if expectations are as they are now in terms of GDP and tourism, where cost of risk could come in. And then secondly, just in terms of P&L, obviously very strong printing commission income in the first quarter. Could you give us a steer on what you would see as a kind of a sustainable run rate from here? Is this strong printing lending likely to be continued or is this more to do with some of the churn you're seeing in the book? And equally in terms of margin impact, the sharp rate cuts over the recent period. How much of that has already fed through in the first quarter number and how much of contraction would you expect in the coming quarters from here? And then in terms of capital, I was just wondering if there is any update in terms of capital requirements and what the moving parts are. What we see, obviously, in part of the bank space is that Part of regulatory requirements have been lowered as a response to the disruption caused by the virus. Could you give us an update on how you see the capital requirements evolving for Ion Bank here? And finally, you mentioned equity holdings led to a loss in the first quarter. Could you give us a feel about the mark-to-market on these equity holdings as of now, as we saw a meaningful rebound in market things? Thank you.

Yeah, thank you. How do you want to divide this, Stefan?

We just need to fire away. Shall I take cost of risk? Yeah. You take commission income? Yeah. You take NIM? Yeah. Capital requirements? We'll sort of go one by one. Okay. Okay, so cost of risk, as I said, we have... No, we haven't given a clear guidance for the full year, and simply because... There is still too much dust in the air, so to speak, on that front. What we have done is we have taken our IFRS 9 modeling. We have taken what was before the worst case scenario. That is now our base case scenario. And that has been modeled into the numbers. And obviously, we have been sort of looking at other downsides, be that mainly the travel industry and single name. And as I said in my presentation, this is the outlook we have now. Obviously, we're also thinking about the sort of the message from the European Central Bank and the Central Banks sort of to look through the cycle. and not sort of overstate things in our accounts. Now, that's why we also say that we cannot exclude further impairments as we go into the year and as, in a way, our clarity becomes better on the economic side. impact of COVID-19. So it's almost impossible to guide on how this will end up during the year.

Maybe to add to that, you will see in a supplementary note or explanatory note number 41 that we've provided a sort of more detailed distribution of the loss allowance between states and industries in our loan portfolio. And if I remember correctly, the overall loss allowance is 1.48% for the whole loan book. But it's higher, obviously, for certain sectors. And I think it's fair to state that the mortgage portfolio tends to have a much lower cost of risk. And we've gone through a number of economic cycles where the loss that banks have faced on the back of mortgage lending has been limited. And you have to keep in mind that LTV requirements have been more stringent here than elsewhere. And the regulator actually reduced that through a regulation a few years ago. And there is a breakdown as well in our financial statement on how this sort of ratchets us up between buckets, LTV buckets. The consumer finance business has a higher cost of risk, but that only comprises 7% of the portfolio. And obviously, when we were doing the IFRS assessment, we are trying to take a forward-looking view. And at this point in time, we think this is a prudent sort of cost of risk allocation. But obviously, if the economy continues to struggle and even faces a more severe economic downturn, then that's going to impact our cost of risk. That's for sure. On the commission income P&L, like Stefan explained, the increase in the first quarter is a function of our strategy in CFB primarily, which has been quite a turnaround in that business in the last few quarters. And it's clear that the capital velocity element of it, it's going to be more challenging in a time where banks are primarily defending the clients and their exposures. But we have a firm strategy in place. We've been building relationships to do more of syndicating and more sales of credit and one sort of things normalize. We're quite confident that we can continue on this path so maybe we won't see as a strong quarter second quarter for this but still you know we're doing we're doing new business and and some of some of it is is being syndicated as well The margin impact is probably not fully into our accounts because the rate decreases happen sort of late in the quarter. I think it's fine to share the sensitivity analysis that we've done that for the 100 base point reduction will impact our NIM by around a billion. On an annual basis. On an annualized basis. And we can't exclude further rate reductions. We still have a higher policy rate here than elsewhere. But that's a situation where we are very well aware of and means that we just have to continue to focus on costs and cost rationalization. That's what we're working on. Capital requirements, I think this quarter demonstrated that when you're running a bank with a standardized approach with almost full use of capital buffers, it's virtually impossible to bring on more capital requirements. And in the quarter, the counter-cyclical buffer was lowered by 200 basis points. and obviously we and and some of the some we got some relief through the SME supporting factor exactly yeah and so you know it We're more moving to sort of lower risk rates, I guess, in that sense. There have been some Icelandic-specific implementations that are now being sort of drawn back. But what's going to impact our risk exposure amount is probably... going to be to the extent that payment holidays are classified as forbearance, that could impact those. We have a very good dialogue with the regulator and we don't foresee any kind of large exposures being classified there. We're doing this according to a guidance and in a collective manner with the whole banking system. But FX movements could impact that exposure and that's actually something that we saw in the first quarter and if the ISK depreciates further, then we will see some of our loan exposures increase in ISK, which will increase the risk exposure amount.

But still, to add to that, it's in a way a peculiar situation that when the counter-cyclical buffer is lowered, it is in a way irrelevant for the bank as the situation is now, because we do have excess capital that... that we have not been able to distribute, which is very prudent now. But in a way, the system is designed for a bank which is running its optimal capital structure. And we were on that journey, but in a way, COVID hit us a bit too early.

A good question probably is when we can start releasing capital back to Xerodos. Yeah. We were in the midst of normalizing the capital structure when this pandemic hit. And we obviously just fall under the umbrella of the European banking system instead of complying or following the strong guidance of the regulator. Equity holdings, there was a mark-to-market loss of 2.4 billion. And we are one of many banks who hold Visa shares through our ownership of Valetor, and that is the largest component there. On top of that, this is a number of equity positions. We have market-making operations here locally, which faced a loss in the first quarter. And then some sort of mutual fund investments and venture capitalist portfolio that we marked down as well from a prudency standpoint.

But the bulk of this is actually listed in the market.

Yeah.

I hope. Perfect. Thank you. Thank you. Thank you very much. Very, very clear.

And just as a reminder, if you do wish to ask a question, please press 01 on your telephone keypad now.

Okay, if there aren't any further questions, and I assume that there aren't any from the auditorium, which is impacted as well by the COVID-19, with very few guests here. But good to see you all. We'd like to thank you for dialing in and watching. And we'll see you in three months' time. Thank you. Thank you.