Arion banki hf.

Welcome to this presentation of Arjen Bank's third quarter results. This was a particularly robust quarter and we continue to deliver on our strategy in a challenging economical environment. For two consecutive quarters now we have posted an above 10% return on optimized equity. And we posted a solid income growth in the quarter of some 6.2%. And our emphasis on operating efficiency is further demonstrated with a lowering of operating expenses by some 11% in the quarter. And a strong cost-to-income ratio, which is now below 50% for the first nine months. Now, it helps to have a diversified income stream in economic situations like these. And our distribution channels, which we have invested heavily in in the last few years, have also demonstrated their value. So for example, volume-driven fees in retail banking are obviously down. due to lower economic activity, but we saw a strong growth in, continued strong growth in lending and guarantees business. And our digital distribution channels have been able to sort of mitigate against the fact that most of our employees are working from home at the moment. But at the same time, we're enjoying the highest growth in markets applications in banks history. And this indeed has accelerated our transformation of our branch network into sales and service centers, which is focusing on providing customers with service and advice with the full product suite. Now, Ariane has a significant balance sheet strength, and Stefan will go into that later on, and a high dividend capacity. The Z1 ratio is now among the highest in Europe and leverage ratio is significantly stronger than European peers because we are one of few systematically important banks that operate with a standardized approach. We have currently over 40 billion of surplus capital on top of our sort of CET 70% target. But in fact, it's closer to 70 billion in excess of regulatory requirements. So quite a strong equity position at the moment. And we have a unique position within our small economy as well, because we have, we say, a broad market access. due to our dual listing and our international investor base. And that has demonstrated itself this year. We've used this strong investor access across Europe and globally to work on our capital structure. We issued additional tier one earlier this year. And I'm sure this will continue to benefit us for the benefit, obviously, of our clients. Now, I said challenging economic environments, and they are indeed very challenging these days. The spread of COVID-19 and travel bans introduced have had a negative impact on the Icelandic economy, especially tourism. But when we compare the GDP changes in the second quarter, for example, with neighboring countries, we sort of rank in the middle. And what has been particularly good to see is the strong fiscal and monetary response. And even though unemployment rate has come up quite a lot, those who are employed are enjoying, as our chief economist pointed out yesterday, in her macroeconomic forecast. The unemployed, the employed are enjoying quite a favorable environment where net disposable income continues to, real net disposable income continues to go higher. Borrowing costs have come down by 30% in the last two years. And house prices continue to rise, so they are feeling the wealth effect of home ownership. And I think that is helping the economy and explains why our market's portfolio is performing particularly strong despite the higher unemployment rate. And as you can see from this slide, the fiscal response has been strong compared to the rest of the Nordics. And there is quite a substantial headroom to do more, as you can see from the leveraged position of the Treasury. Now, I mentioned the sort of investments into digital channels and how that's benefited us in these challenging times. And it's very interesting to see that due to obviously lower interest rates and high activity in refinancing of markets, we are seeing the strongest growth for new markets applications in the bank's history. And as you can see from this slide, in the first nine months, we have now processed more markets applications through our digital channels than we did for all of the market's applications in 2018 and more than twice what we did last year. So our investments are proving to benefit us and be a success. And we have our employees taking advantage of the digital channel streams and being able to service our clients even from home. Now, we've been focusing as well on new products, and we are influenced by our ESG strategy here. Our latest product is the green markets offering, where we are offering those who are investing in residential property, which has been environmentally certified, a zero loan origination fee. And that is, for example, financed through the bank now with green deposits, which we rolled out earlier this year. And we're also taking part in making our car fleet greener because we have a better offering for car financing on vehicles which run entirely on electricity or other renewables. Before I hand over to Stefan, I just want to go briefly through the earnings bridge for this quarter, which I'm particularly proud of. As I said, we're delivering on our strategy. The increase in core income is 6%, just over 6% of the quarter. And if we adjust for the redundancy costs that took place in the third quarter of last year, Our operating expenses are down by 11%. Combined, this amounts to some 1.3 billion in the quarter, which is close to actually 1% of our set one capital in the quarter, or then close to 4% on an annualized basis, pre-tax. which is quite an achievement, but we will continue to focus on both items, both the revenue items and the cost items. And with that, I hand over to Stefan Pedersen, the CFO.

Good morning, ladies and gentlemen, and thank you, Benedikt. Let me just sort of reiterate what Bennett has said. We are delivering on strategy. Our balance sheet is very strong. We do have ample dividend capacity. And thirdly, we are actually closing in on our medium-term financial targets. And if we look at the highlights of the third quarter, then On the strategy, our NIM is improving 30 pips year-on-year. We are seeing net interest income to credit risk improving year-on-year. Our core revenues, as Bente said, they're up 6.2%. And OPEX is down a massive 25%. But if we exclude for one of items, it is down 10.7%, which is quite substantial. We are turning around the operations at Valetor, maybe not fully out of the woods yet, but a massive improvement there in the first nine months of the year. Our risk exposure amount remains stable, even if the balance sheet is growing, and we have surplus capital that we very much would like to return to our shareholders at the earliest opportunity. Looking at the medium term targets, our return on equity in the quarter was 8.3%. It is actually 10.4% when we assume our 70% target C81. Our operating income over risk exposure amount was 7.2%, well above the 6.5% target that we have. The cost to income ratio, I tend to look more at the nine months rather than the quarter itself. But we are below our 50% target for the first nine months at 49.5%. And then see the one ratio where our target is 17% is 22.5%. But that is both a challenge as well as an opportunity. Looking at the income statement, then we can see that on a core basis, interest income, commission income, and insurance income, the story is very positive. Maybe especially on the interest income side, where we had an 8% growth year on year on a relatively similar loan book. Operating income in total is 5% up year on year. And then over to the salary side, a wobbling 39% decrease from the same quarter of last year. But then again, we need to remember that we had substantial redundancy costs. in the third quarter of last year. But still, total OPEX is down 25% and again 10.7% if we exclude the one of last year. The bank levy has been reduced. It is now 14.5 basis points down from the 37.6 basis points that we started the year out with. And this lowering is here to stay. Net impairment in the quarter is $1,340 million from 19 basis points, and earnings before tax are up 19% from last year. Income tax, relatively modest in the quarter. So net earnings from continuing operations are up 31% year on year. So as you can see, we are very much delivering on what we set out to do. We do have a markdown in our health for sale assets. So discontinued operations are negative by almost a billion, taking net earnings to just under 4 billion ISK. which is up more than four times from the same quarter of last year. We are very proud of our achievements on the loan book and the funding side. We are able to maintain the NIM at 2.9%. In a challenging environment, the base rate is at an historical low. We've been issuing Tier 2 and 81. We have, in a way, excess liquidity. But at the same time, we're able to maintain NIM at 2.9%. And we are increasing net interest income substantially year on year. And we are maintaining and actually increasing our net interest income over credit risk. So I think that says a lot about our management, both on the lending side and on the funding side. And in a way, that is demonstrated at the bottom graph there on this slide, where we see that, yes, we do have lower income from bond holdings and loans to credit institutions and from our loans to customers. Our sub-debt is obviously more expensive than other funding, but that is more than made up by lower cost of deposits, lower cost of wholesale funding, and inflation, which is slightly higher this quarter than it was last quarter, or same quarter last year is also sort of assisting the situation. OPEX is trending down, which is very positive. This has been and will continue to be a focus point at the bank, as is the case with, I think, every bank in the Western world. As I said before, our cost-income ratio during the first nine months is under 50%. It's just over 40% in the quarter. We are seeing the number of employees down 5% year on year at the bank itself. And this is a trend that we can expect to continue. OPEX is stable and other OPEX is stable. And that is something that we will obviously continue to look at very closely as well. The balance sheet, strong, simple. It grew by some 14.3% from year end. The increase mainly being liquid assets. Our loan book increased by 4.4% and is well sort of diversified between individuals and corporates. And our liquidity position is very, very strong. Total LCR of over 200% and 177% in ISK, which means that we as a bank, we are in a very solid position to either support our customers or eventually distribute capital. Loans to customers are rising, as I said, 4.4%. That is almost... solely in the mortgage space where we have been very active and we have seen both new mortgage lending and refinancing amounting to almost 70 billion in the quarter, 150 billion year to date. There is a slight concern there in a lowering interest rate environment that the front book is comes at a slightly lower NIMS than the back book, especially when funding rates and mainly deposit rates are closing in on zero. But luckily, we don't expect the base rate to fall any further than it already has. It is now at 1%. COVID-19 obviously has impacted banks, and we have done a special study on sort of how COVID, or basically how COVID has impacted our loan book. As we see it, obviously, we use IFRS 9. We don't feel that that fully sort of fathoms the situation. So we have made certain management overlays on the loan book. But our conclusion is that COVID impacts around $150 billion of our loan book, around 18%. Out of that, $118 billion is collateralized with real estate. And what we have done in our assessment is that in our overlay, we have basically downgraded sort of the affected sectors as we see them or the affected groups of loans. We have downgraded those and increased impairments. We have also given out payment moratoria or payment holidays on both to individuals and corporates. and it is actually very interesting to see the the development of this we see that on the right hand side of the graph started this in in march and we saw individuals picking up on this very quickly and and and and payment holidays or payment moratoria for individuals peak in in in may but but it has been coming down ever since and this is now only at 10.5 billion on the corporate side The corporate started slightly later, started in April, and it has been trending up, and in a way, we believe the jury is still out on how that will continue on the corporate side. Same with loss allowance. That has been increased substantially. Clearly, as you see there on the right-hand side, the tourist sector, we have increased sort of been very active on that front. That sort of feeds into the corporate side for the most part. But the interesting thing is that we have not had to increase allowance on individuals. It has actually been stable. And as Bennett said, most of our individual lending is mortgages, and that asset base is actually in very good shape. The liability side is, as before, well balanced, very strongly capitalized and strong leverage ratio, good balance in our wholesale funding, both in cover bonds and senior and secured. We have not been active this year on that front because we have been so liquid. And we have been liquid because of the growth in the deposit space. And we are particularly pleased to see sort of our core deposits go up by some 11% from year end. And when we say core, then we're talking about retail SMEs and corporates. We talk about capital strength all the time, and that's because it's true. Our capital ratio is 27.6%. It is down slightly from the second quarter for two reasons. We had a small increase in our risk exposure amount. And then we have started again what we did not do in the second quarter. We are deducting 50% of net earnings according to our dividend policy. And we feel that that is an appropriate sign to the market that we want to pay dividends when the central bank opens up for that. And we hope that that will be next year. Leverage ratio at 14.3%, which is obviously very strong in an international context. So to conclude on our side, I mean, we feel that we are delivering on our strategy, but we aim to do better. We will continue on this path and build on what we have achieved over the last two quarters. Clearly, we're a part of the ethnic economy. But we feel we are in a very good position to be a part of the rebound of the economy that we expect will happen next year. There's obviously a lot of economic uncertainty still due to COVID, and we see what's happening both here in Iceland and around the world. Still, we believe that we are seeing better sort of into our asset quality. Again, we have had massive impairments, not massive credit losses. They may start in the new year, but we hope that we have already impaired part of what may happen. We have not ruled out the possibility that this situation may lead to some opportunities. And it goes without saying that we are following closely the discussion that is taking place both in the U.S. and Europe on bank dividends. And we obviously realize how important it is for our shareholders that this bank is able to continue its capital release. So having said that, I think we give it over to the moderator for Q&A. Thank you.

The question, please dial 01 on your telephone keypads now to enter the queue. Once your name is announced, you can ask a question. If you find your question is answered before it's your turn to speak, you can dial 02 to cancel. So once again, that's 01 to ask a question or 02 if you need to cancel. Our first question comes from the line of Johan Slom of Carnegie. Please go ahead. Your line is open.

Thank you very much, and I would perhaps like to start by congratulating on a really good quarter in challenging times. It's good to see the strong cost-income ratio line. I would like to ask you to be a little bit more precise on how we should think about some P&L items, and first on costs. The Q3 level is low, of course, and have really improved the cost development further. But how should we think about the run rate going forward? Is it fair to assume that quarterly costs will be below six billion, for example, in the next couple of quarters?

Thank you so much. If I answer this, there is clearly seasonality in our salary line, and that is due to vacation, so when employees use up the vacation allowance. then we have already accounted for that as an expense and that reduces the salary line. So I would encourage you to look at the seasonality from previous quarters as well. But then there are clearly sort of impacts from sort of COVID-19 related impacts. Traveling expenses are down and other sort of employee related expenses are down because people are mostly working from home. But on the other side, I think we will continue to focus on costs and one cost item that is under special sort of... because scrutiny scrutiny now is the is the it cost which is the largest cost item and we've historically invested quite quite a bit and and now we sort of think that we can reap the benefit from that and so yeah a continued focus on on costs and effort is always to bring it further down

If I add to that, I think, Johan, you need to look at the trend sort of over a longer period of time, and I think we cannot give out an exact number on that. Sure, okay.

Thanks, anyways. On commission income, then, it's kind of stabilized at very high levels now for the past three quarters, but is it fair to assume that we... You should look at these loan prepayments as a kind of a non-recurring item. I mean, you've come up, but especially the lending guarantees contribution to a quite high level close to a billion. How do you think about this? Is this non-recurring or something that we should expect in the medium term as well or just a kind of a short term item?

Actually, it's to a limited extent because of loan repayments. Most of the mortgage portfolio does not enjoy that kind of fee structure, but there are some sort of seasoned entities that have that. But it's primarily because our focus on capital velocity and charging sort of more for the use of our balance sheet that is resulting in this. And we're quite confident that we can continue on that path. I think historically, the bank in comparison, maybe generated less of fees and commission income from this activity. And I think we're now closing in on some of our peers.

For sure, something very positive. Then lastly, can you say a few words on the competitive situation in Iceland now? Are the pension funds able to follow you down on pricing? And if not, do you think that you can maintain the high growth pays sufficient margins in the near term?

That's a really good question. Currently, the real policy interest rate level is negative. So, the inflation is hovering around 3% and the policy rate is at 1%. And that has made the banks more competitive when it comes to the market space. And the most favorable product or the most sought after market product is the non-CPI variable rate product. I think more than 80% of the demand is in that asset class. And the pension funds have not been willing to engage in competition for that product. They continue to offer the best rates when it comes to fixed CPI and even variable CPI in some cases. But that is not the product that our clients are preferring at the moment, and that's why we, for the first time in a long period, are enjoying a favorable competing position. And that belongs to all three banks. They're enjoying the same kind of increased activity.

Yeah, it sounds a lot better. So thanks very much for that, Benedetta. And let's hope we can see another quarter like this in Q4. Thank you.

Thank you.

Thank you. And our next question comes from the line of Marcus Hobbs of Goldman Sachs. Please go ahead. Your line is open.

Hi there, good morning from my side as well. Just a couple of questions, please. So firstly, it's good to see that you're now back to accruing dividends, 50% of your 2020 profits. But I was just wondering, how would you think about proposing dividends for 2019 profits, given the very strong capital position that the group has? And how would you – is there any regulatory approval that you would need if you wish to do so? Because obviously we've seen a couple of few banks in Europe now that have done that and one in the Nordic space as well. So that's my first question. And second question, just on the corporate segment and in particular the repricing of the corporate book that you've been talking about in the past. So I'm just wondering, is that something that you're still pursuing or doing, or what is the progress here? If you can just update on that. Thanks.

Thank you, Markus. Good questions. If I start with David, and I know what you're referring to, and we had a look at it. And actually, the Icelandic legislation does not sort of limit us as, for example, in Norway when it comes to dividends. So any retained earnings that we have, irrespective of from what year, can be distributed. In later years. So, you know, there is not a cut off at the end for this. What we said previously said is that we just follow the guidance of the regulator and we will have to see sort of what we would like to see is obviously that the The regulator would put some kind of a quantitative measure on sort of capital strength and allow banks in Europe to release some of the excess capital that then is with the stronger capitalized banks. And the sort of blanket dividend restriction is not a good thing in the long run for, you know, banks that tend to have fairly high capital and have to rely on equity investors for the capital that is deployed in the business. um so uh but uh you know retaining stephen if you want to elaborate a bit on sort of our pro sort of accounting method for retaining the dividends now yes i mean we what we did last year because you thought you asked about two 2019 dividends uh we we we actually did

In our 19 disclosures, we did assume 50% payout. And we altered that when we had a dividend proposal of $10 billion. And when that was canceled, then we added that back to our capital position. So when paying that out, that will be an extraordinary dividend payment. But as Benedict said, there is nothing that prohibits us from a regulatory perspective of paying extraordinary dividends. So in our case, that really doesn't matter too much. And as Bennett said, the only sort of regulatory hindrance that we would have on distribution is on buybacks when we need a formal approval from the regulator. but obviously we listen closely to what our regulators are saying on dividends and it is obviously very positive for us when we listen to what's happening in Europe, that the ECB seems to be worried about the effect on investors and obviously that a blanket ban is maybe not the best idea.

Exactly. On the corporate book, I mean, this is a continued effort to reprice the book. But I think actually the same applies here as for the markets, markets is now. When we have real interest rates, policy rates at minus one and a half, minus two percent, I think the bank is in actually a pretty good position competing for some of the corporate credit here locally. A lot of sort of longer maturities are CPI linked fixed rate predominantly sort of invested by or financing provided by the pension fund system. But we are now enjoying sort of healthy demand for sort of non-CPI variable rate financing. And I think, you know, many of our clients, they have a pretty sort of, they're comfortable with the interest rate levels now and don't see the policy rate moving higher anytime soon. And I think that is, you know, partially a function of the fact that Iceland is now, even with a really small currency, is supported by strong sort of renewable export industries, both on the energy intensive side and then for protein, fish. where we're seeing sort of salmon fish farming, the latest newcomer here, with big growth coming from that sector. And then the fact that, as our chief economist pointed out yesterday in her microeconomic forecast, that we've enjoyed seven years of current account surplus, and she's forecasting that we will have a positive balance of payments for the next three, four years as well. So there is no, even though there's temporarily a strain on the krona now, once things normalize, she's expecting the krona to strengthen again, which is also supportive for sort of lower policy rates for longer. So the interest rate environment in Iceland is changing. And that's to the benefit of banks rather than sort of the pension funds.

All right, great. Thanks for that. Thank you.

Thank you. Our next question comes from the line of Maria Shenigatova of Citibank. Please go ahead. Your line is open.

Yes, hello. Thank you for the presentation. A couple of questions from my side. First of all, following up on repricing the corporate segment, because there are different moving parts. You mentioned that you see front book pressure in the mortgage lending. Also just want to check if all the rate cuts that have been implemented so far already filtered through your NAI line. Just maybe generally how you see your margins developing from here. Second question on asset quality. Could you maybe shed more light on payment holidays that you provided for corporate customers when they expire, how customers behave so far if there's been any expiration, particularly on the corporate side, maybe more generally since you said that you have better visibility now in the asset quality outlook. Are you comfortable to provide guidance for cost of risk for next year? And just want to confirm, What is the outlook for 2020? And just finally on opportunities that you could see in the sector. How aggressive would you be if there is still regulatory ban on capital distribution? And maybe if there is anything you can expand on potential consolidation in the banking sector. Thank you.

Very good questions. On the sort of NIM going forward, as Stefan mentioned, there is clearly pressure on our markets portfolio where the front book is due to high refinancing activity is probably enjoying slightly lower NIM than the back book. So that will put a pressure on NIM, but we're hoping that we're able to mitigate against that with sort of continuing to reprice our corporate book. and to an extent consumer finance which we've not been very active in. The consumer finance portfolio is relatively small with the bank so there might be an opportunity to selectively go further into that space. So I would say sort of assuming that the policy rates do not move any lower, that it would be a good outcome if we were able to maintain the current kind of lim position. Would you agree?

Yeah, that's a very good way of putting it. We feel that the risk is more sort of on a slight downside, but obviously we are fighting to maintain it.

Yeah, precisely. On asset quality, as Stefan mentioned, we've identified 18% of the portfolio with COVID-19 related exposure, but a lot of that is collateralized with real estate. And we've been conservative on the LTV side. I think we discussed it in our AGM, if I remember correctly, the LTV in our commercial real estate portfolio averaged some 67% in end of last year, but commercial real estate prices have come down somewhat. But there is a buffer, as you can hear. The industry-wide payment holiday or payment moratoria elapsed end of September. and going into that to our surprise because our clients were able to in the market space to use their ability before end of September to extend for another three to six months. Most of our clients didn't and that explains why we have such a low ratio of residential markets borrowers in moratoria at the end of the third quarter. But it's also low for corporates because this industry-wide effort elapsed. And what we will now do is do it on a case-by-case basis, and I expect that we will see payment moratoria creeping up again or increasing in the next few quarters. But that is primarily related to this 18% kind of exposure. Other industries seem to be doing quite well. And if you look at all sort of some of our largest exposure towards large sort of operating companies, some of them listed on the stock exchange, the leverage ratio is quite low at the moment. in historical context. Now, the third question was on... But let me just add to that.

I think also what you need to assume, we believe that cost of risk will come down, but it won't normalize next year, but we believe it will come down and normalize over let's call it two, two and a half years.

And we're hoping that what we've already impaired and we'll have to realize as losses in first and second and maybe third quarter of next year will suffice, that we've been foresighted in our provisioning. Exactly. The opportunities in the sector, it's a very good question. We would like to grow our asset management business and we're seeking opportunities to sort of grow externally or internally there by investments. I think in most other spaces I mentioned consumer finance as a potential growth area, that would be an internal growth thing primarily. But I think due to our market position, there would be constraints to other acquisitions here locally. And we, up until now, have not defined our kind of core home market as anything else than Iceland. But we have indeed sort of a decent size portfolio towards the seafood industry in Europe and North America. As part of that, we have been active in Faroe Islands, for example. That could be an opportunity as well. Due to our size, there is clearly limited growth potential and investing into asset management, which is in itself not a capital-intensive business, will not require heavy investments.

Thank you so much for a very detailed answer. Just maybe a quick follow-up. I don't know if I'm looking way too much into the future, but since you mentioned the normalized cost of risk, so what do you see normalized? I'm not pressing for timing when you think that's going to happen, but with your current portfolio breakdown, what do you think is an appropriate cost of risk assumption?

We haven't given guidance on that, but one reference point that I would like to point you to is the fact that 43% or 42%, 43% now of our loan portfolio are residential marketers and they enjoy much lower cost of risk than anything else in our portfolio. And I think our models, if you look at our pillar, the latest pillar three report, assume somewhere between five and seven basis point cost of risk. uh and it would uh and based on on sort of our our competitive position there and and the activity in in our business uh residential markets will will be a key pillar of our credit portfolio and it would be really good to see other kind of exposures normalize uh the cost of risk level which is What did you say?

The low 50 basis points or even lower? Yeah, even lower. Let's be careful on that because we haven't guided on that.

No.

But at least, I mean... Thank you so much.

Thank you. Once again, if there are any further questions, please dial 01 on your telephone keypad now.

okay and we don't have any audiences in the auditorium so i guess this concludes our presentation thank you very much for listening in and all the good questions that you came with and we see you in in three months time thanks