Arion banki hf.

Good morning all and welcome to this investor webcast of Arion's first quarter results for 2021. My name is Benedikt Gislason, I'm the CEO of Arion and I will be going through this quarter's results along with Stefan Petersson, the CFO. This was a particularly good quarter, our best quarter in four years. And the bank's revised strategy continues to deliver. The return on equity was above 10%. And if we look at our optimized equity, the sort of the target equity that we intend to use in our business, the ROE is much better, around 15%. We continue to deliver on income growth in this quarter, 4.2%. and also a decrease in OPEX of 3% from the same quarter last year. What is impacting this quarter as well are positive impairments, and this is not due to any changes in our IFRS models, but has to do with the fact that our clients are doing better. Many of our companies that bank with us have navigated through this pandemic in a good way and show increased financial strength and that merits improved credit ratings. And also for our kind of troubling loans, we've seen impairments being reversed due to payments on these impaired loans or increase in collateral value. This was a very active quarter in terms of trading in our shares and a really strong performance, outperforming the OMEX Iceland and the large and mid-cap Nordic peers, which was particularly pleasing because in this quarter we saw two of our largest shareholders selling completely out of its holdings. Through this, we saw an increase in number of shareholders from 7,400 to 8,250 or 12%. But majority of shareholders continue to be Swedish investors. In this quarter, we paid out 2.9 billion in dividends and bought back around 11.9 billion of market value of our own shares after having received the permission from the regulator to do so. But we continue to enjoy one of the highest capital ratios of European banks, with leverage ratio which is significantly stronger, and still a 41 billion surplus capital plus another 3 billion of retained earnings that we intend to pay out as dividend. That's from our first quarter results. Now we are seeing the light at the end of the tunnel. And Iceland is now navigating better than ever out of this pandemic. And we now expect all residents 16 years and older to be vaccinated before the 30th of June. And by that time, we will probably see all domestic COVID restrictions lifted. And that is when we will start to see our offices fully return to normal, which will be good for a culture of collaboration and innovation for our firm. The outlook for one of our larger export industry tourism is looking better than people were hoping this spring. Bookings, speaking to our clients, we hear that bookings are up quite a lot. And it's clear that this is going to be driven by vaccinated tourists primarily from the US and UK probably. And so the forecast for this year of 600,000 visitors is actually maybe not that optimistic, but what is important to note as well is that the shift that Iceland took to move into more lucrative tourist activities had already started to happen in 2019 and 2020 on the back of the collapse of Vauer. And this, we think, is set to continue when travel and tourism resumes. So Iceland is moving away from the model of more tourists, the better. to one of the higher expenditures, more nights and premium tourists. And you can see that actually from the hotels that are set to open this year, that these are high-end hotels and tailored to this particular client base. And what is good to see is that the number of airlines have already either announced that they're taking up flights to Iceland or have already started, like Delta, which brought the first U.S. tourists vaccinated to the country last weekend. And this is clearly going to have an impact to the economic recovery of Iceland, and we are probably more optimistic about that now than we were a few months ago. And I think it's fair to assume that we won't see any further reduction in the policy rate, as inflation is now hovering around 4.6%. And it's rather a matter of when we start seeing rates hike. We, however, do not expect the inflation to be long-lived. And we will see if tourism starts really picking up that this is going to probably impact the exchange rate and imported inflation will not be an issue. Now, digital solutions have impacted our customer interactions and sales significantly, and we continue to increase our sales through digital channels. and have also taken up digital interactions in new ways like web video conferencing. So our clients do not have to book meetings at the branches and can book meetings online. But what we're also very focused on now is to optimize the customer journey and service excellence. And we're looking to beef up engagement, improve conversion rates, and process efficiency, and gain better visibility to risks and friction areas. To that strategy, we rolled out two new services. Recently, the pension fund solution and onboarding system, which has already won an award as an outstanding digital solution. But secondly, we have recently rolled out as a minimum viable product, a premium service, which is tailored to the high value core client base that require more personal banking services. And this is something that we see as a major growth opportunity for us. Now, we've also incorporated Vörður into our customer journeys and intend to do more of that going forward. And as you can see from this slide, Vörður is enjoying healthy growth in markets here. It's one of the better performing insurance companies in Iceland. And we believe that we can continue to grow this business. and improve profitability further and make it a tier one operator within the insurance space. In April, we completed one of our largest IT investments so far, which was an upgrade of our core banking system called Sopra. This is a key milestone in supporting open banking journey and reducing IT costs in the long term. And some of the future benefits of this is going to help us in our open banking journey. And this will shorten the development cycles for our digital products. And we see, because we're sunsetting a number of systems against this, our IT architect is gonna be simplified greatly. We see this as an opportunity to reduce operation costs further. and reduce the technical complexity in our operations. This was an investment of 4 billion and will be amortized over the next 10 years. That concludes my section of the presentation, and now I hand over to Stefan Peterson, CFO.

Thank you, Meredith, and good morning, everybody. It's a pleasure to be here. As Ben said, we had a very good quarter. In a way, a quarter where everything worked out nicely. I mean, we saw call returns up 4.2% year on year. We saw OPEX coming down. And we saw other items pretty much all being favorable. And to note on that, we met pretty much all of our financial targets during this quarter. And that is something that we are obviously striving for every day. Our return on equity being 12.5, exceeding the 10% financial target. Our return on equity assuming the 17%. CET1, way higher than our target, at 16%, operating income over REAs at 7%, exceeding the 6.7% target, and then cost to income being at 46.2%, slightly over our 45% target. So, in a nutshell, a very good quarter. If we look at the income statement, then it's just reflected in the statement. We see that net interest income is up from the same quarter last year. We see net commission income being very strong, as is insurance income. The net financial income is in a way transforming itself from the first quarter of last year, obviously when COVID hit us. But we have had both our equity and bond positions have been actively managed and are yielding very good results. So operating income is up some 46% year on year. We have been able to continue to lower our operating costs by some 3%. And we will continue to work on that. Impairments may be as a bit of a surprise. They are positive during the quarter, as Bendix said. It is not because we are changing our models. It's because of activities actually in our loan book where our customers are actually doing better than we would have anticipated, some of them. And we are seeing increased collateral value and payments of loans that were in Stage 2. So earnings before income tax are almost $7.8 billion. Income tax is basically as we would expect. So earnings from continuing operations are just under $6 billion. And we have a substantial change from the last quarters, really, in the... in the discontinued operations line. You may remember that we said after the fourth quarter of last year that we expected this line to sort of turn into neutral to positive this year. And we are very happy to see that this is turning out sort of in line with our expectations during this quarter, meaning that we have net earnings of just over $6 billion. It is not all easy, truth to be told. And we are fighting a defensive battle when it comes to our net interest margin. It drops by 10 basis points from last year. And there is a substantial drop from the fourth quarter of last year. In a way, what is happening is that the extremely low interest rate environment is is sort of really taking effect. And in a way, we were sooner to react on the funding side, and now the lending side is sort of catching up. Obviously, we should also add to that there are changes in our loan book. Firstly, we are seeing an increased portion of mortgages in the loan book. which should weigh on NIMS. But also, we are seeing a shift in the domestic market when it comes to indexation of loans. So our indexation in balance is reducing. And so we are seeing less impact of the inflation from what we saw in sort of the previous quarters. This also feeds into net interest income over REAs. Sorry, over average credit risk, an indicator that we follow very closely. That is slightly down from the previous quarters. And we, in a way, expect to... Our expectation is that whilst we have this super low interest rate environment, we will be sort of in the 2.6 to 2.8 NIM range. Fees on commission and insurance income, they have been improving in line with our strategy. we are improving on pretty much every front when it comes to commission income, with the exception of collection and payment services, where in a way we feel that glass is half full instead of half empty. Clearly sort of tourist-related turnover still has, or we expect that to come into our business when the economy picks up. But we are particularly pleased to see how the merger of corporate banking and investment banking has resulted in increased activity in the merged CIB. And it's interesting to see that we are not seeing growth in the corporate loan book during the quarter. But we are seeing massive growth in sort of corporate loan book activity and capital velocity. And that is feeding into fee income. On the insurance side, the best quarter for Werther ever. Very solid combined ratio for Q1. And we have high hopes for Werther continuing into the year. On the OPEC side, then, we have been hovering around the 45% cost-income ratio during the last few quarters. We continue to reduce the number of FTEs, and we see that continuing. We're always trying and aiming to rationalize. We are also seeing a reduction in other OPEX. IT is still by far the biggest expenditure item, and we hope that the Sopra core system will help us rationalize on that front, and we have aimed for that. But then at the same time, we should acknowledge that there are cost items which are unusually low during or have been during this last year. few quarters due to the pandemic. The balance sheet, as before, is strong and simple. Loans to customers are around 71% of total assets. And as you can see, they are evenly spread between individuals and corporates, and actually the individual side, or the mortgage side more specifically, has been increasing in our portfolio. And as I said before, when we say that mortgage lending is up 3.7% and we say there's a reduction in the corporate loan book, that is not because the corporate activity is low. It's just that we both sell and syndicate our corporate loans. Our liquidity position is strong. The LCR is 192%, 153% in Icelandic kronor. So the bank is in, both from a capital and liquidity perspective, in a very good position, both to distribute capital and to support the Icelandic economy through lending activities. On the liability side, as Bente said, the capital position and the equity position is very strong, leverage ratio of 14.7%. balanced funding profile with sort of deposits increasing in the funding mix. And we have been, during the first quarter, we have been distributing capital, as Bente said, both through dividends and share buybacks. And I think we were the only, I don't know of another bank in the European Economic Area which was allowed to buy back by back on CS during the quarter, and we feel that's a testament of our financial strength that the regulator was willing to allow us to do that. Finally, on capital, the capital ratios are super strong, as ever, 26.9%. Total capital, 22.4% in C81, up 10 pips from the end of the year. And in this, we have already calculated the buybacks that we had left at the end of the quarter and 50% of net earnings for the quarter. And what this means is that we have 41 billion of surplus capital right now, and that comes on top of a very healthy management buffer of 26 billion. And as you may remember, the countercyclical buffer that was lifted, we include that in our management buffer. So where do we stand? We feel that we aimed with a very solid strategic vision. We will strive to build on the positive progress that we have had so far during the last few quarters. We expect the economy to pick up in the third quarter. That will obviously offer a number of opportunities for the bank. And as Bennett said, our expectation for recovery has been, in a way, moving closer rather than further out, which is a very positive thing. When it comes to the development of the loan book mortgages, sort of when it comes to building the loan book, Mortgages will be in focus as well as our increased focus on ESD. But then we will continue our activity on the corporate side, both when it comes to lending as well as managing position for our customers with their interest in mind. We feel that the reduction in economic uncertainty allows us for improved visibility on asset quality. 94 billion or 11.2 billion of 11.2 percent of of our loan book is sort of affected by covet most of that is is has is is is very solidly collateralized and and the risk allowance hasn't hasn't moved during the quarter so so this improved visibility com is is very welcome for us uh We are already committed to our capital release strategy, and hopefully we will continue to work on that. And in a way, we don't see anything prohibiting us from releasing up to 50 billion of capital over the very near term. So having said that, I think I hand the floor over to the moderator.

Thank you. If you wish to ask a question, please dial 01 on your telephone keypad now to enter the queue. Once your name's been announced, you can ask your question. If you find it's been answered before it's your turn to speak, you can dial 02 to cancel. There'll be a brief pause now whilst we register your questions. Our first question comes from the line of Martin Leibkitt of Goldman Sachs. Please go ahead. Your line is open.

Yes, good morning. Thank you for taking my questions and congratulations to the strong quarter. I have four questions, if I may. And the first one is on NIM and the market decline in the first quarter. And I was just wondering, is there any one-off impact impacting that progression down in the first quarter, which might explain the comparatively large move. And I'm also wondering if the impact of lower rates and the smaller inflation linked book now fully fed through, is that what gives you the confidence that the margin will stay within the 2.6% to 2.8% range? Secondly, loan growth seems to have been strong in the quarter at a base of circa 7% annualized. Is that a good guide for the run rate going forward? Just given your earlier comments in terms of economic recovery in Iceland, I was just wondering if you could give us a skier what the scope for loan growth is, in particular this year and next year. Thirdly, on fee income, I was just wondering... how to think about lending and guarantees contribution to fee income going forward. This seems to be comparatively stable and on an increasing path. Were there any special impact in the first quarter for the print? Or is this essentially your work done and we can expect that to continue? And lastly, fourthly, just to pick up on your comment on capital return just a moment ago, So nothing to prevent you in principle to return. How long do you think could it take to normalize the capital structure? So to return the excess capital, is this something which could take multiple years? So is there a potential path that this could occur quicker? Thank you.

Thanks, Martin. I think we've written down all your questions. Very good questions. If I could start by answering your last question on the capital return. I think this is somewhat a function of our capital generation and profitability. If we continue to deliver quarters like this, I'm sure that we... will be in a position to accelerate the capital release further. But in the near term, I would say, means that we would, within, I guess, the next 18 months, want to have a normalized capital base with everything else staying the same. But as I said, if the capital generation continues to be so strong as it has been in the last few quarters, this could give us an increased sort of optimism to do it quicker. I'm going to refer the NIM question to Stefan, but talking about the loan growth and fee income and lending and guarantees, maybe answer it sort of a bit together. So as we stated in our press release, even though we didn't see any growth in the corporate loan book, the activity was quite high. So there was a lot of of credit going through our CFB unit and doesn't end up on our balance sheet or is sort of short-term financing. And that is actually part of the revised business strategy that we presented in November 2019 in London. and and that is resulting in in a much higher fee income and from the lending and guarantees line item and that is something that we envisage to continue this is a strategy that we were very pleased and happy about having adopted And we see there's a market out there for this. And this is one of our ways of gaining competitive advantage and being able to offer our clients better terms with financing from third parties. So the loan growth primarily comes from the growth in the mortgage book. And it's currently tracking a bit ahead of our kind of budget for the year. And we've said that as long as the real policy rates remain negative, they are obviously massively negative at the moment with CPI. running at 4.6% of the policy rates at 75 basis points. But as they continue to be negative, we have competitive advantage towards especially the pension funds. So we expect this to continue at this rate, yes. And we're seeing massive activity. Almost half of our mortgage book was refinanced last year, But the good thing that we're seeing now is we're adding on new clients. And this is very sensitive to interest rates. And we are now currently offering probably the best interest rates or among the best in the market. And that is, so it's our intention to continue to grow this book. We see this is conservative asset class. The LTVs are relatively low compared to, let's say, rest of the Nordics. And it offers a good return on capital because this deploys less capital than some of the riskier credit exposures with 100% risk rates.

If I take the NIM, as I said, I think it is a defensive battle. I think our belief is that we are bottoming out and hoping to sort of manage to stay above the 2.6% level in NIMS. I mean, this obviously is massively affected by the base rate, which is at 75 basis points right now. We feel that there is clearly our deposit basis more or less at zero, so room for maneuvering our funding costs lower in a rate cut is minimal. However, looking forward, we feel that the risk of a further rate cut is extremely low, as we see it now. And we are starting to believe that the bias is on the flip side, that the central bank will act in the not too distant future. I think I would put it that way. And that is definitely positive for our NIMH.

there is a much higher proportion of our credit book now on variable non-CPI rates, which means that we have better control, I guess, of sort of the pricing and managing on that interest margin.

Thank you. Thank you very much. Very, very clear.

Thank you. Our next question comes from the line of Johan Strom of Carnegie. Please go ahead, your line is open.

Thank you. Two questions for me. First, thanks for the presentation and congratulations with a great quarter, Benedikt and Stefan. With the outlook of increasing interest rates, or at least in that direction, should we expect competition from from domestic pension funds to increase as well. And then on costs, Stefan, you mentioned lower activity-related expenses in Q1. Just curious on where it is hitting the P&L. This quarter, I've noticed a very low other operating expenses in particular. So should we expect an increase in this with a gradual reopening and more people at the office? Thank you.

Thanks, Johan. Let me start by answering your first question on the competition with the pension funds. As I mentioned earlier, the pension funds are very sensitive to inflation. Their asset versus liability calculations do account for inflation, and that's why So when the nominal rates are in the kind of negative territory from a real interest rate level, they opt out. And they've certainly done so in the last 12 to 18 months. And whilst that remains, we won't see them, in our opinion, we won't see the pension funds actively competing for market share in the market space. And what we rather foresee is that their investment allowance abroad, which is now currently capped at 50%, would be increased. And they will continue to diversify out of Iceland and invest into other asset classes outside of Iceland. This pension fund system has outgrown the banking system and is set to be... grow further in the next 15 to 20 years before it sort of maxes out in size. And this diversification is really needed and welcomed as our export industry, if they start picking up again, that could put pressure on the exchange rate appreciation of the corona, which is something that I'm sure the central bank is worried about. So, yeah, we're hoping to continue to enjoy this kind of advantage in the market space for some time to be.

If I talk about the cost side, I mean, as I discussed, we are obviously focusing heavily on ideas. There's a big cost item. We also feel we are doing well on the housing side, and basically we are working on the cost side. But, I mean, there has been very little human interaction over the last... year or so so when it comes to when it comes to marketing when it comes to traveling and so forth i think we should expect to see that creep up a bit over time but it it won't tilt anything it's just just i mean i think it goes for every corporate in the world that will see an increase in that in in the coming in the coming or i hope in a way i hope we'll see an increase in that in in the coming months

We have a kind of... To support our 45% cost-to-income ratio, we have a cost rationalization program in place, which we are tracking every month and very firm about sort of keeping a lid on costs going forward.

Thanks very much for the call. Benedikt, just back to your... Back to your comments on pension funds. Just to be clear, they have mandates and there are no restrictions for them to focus their investments a little bit more on international stuff. It seems very good. It seems like you're in a very good environment for continuing a strong and profitable growth within mortgages. I'm just really curious about hearing your comments, which I really appreciate.

I mean, currently their foreign investment portfolio is just over 42% or so, if I remember correctly. And the current legislation stipulates 50% maximum exposure abroad. But the public discussion has been to increase that. I mean, we've seen... If you look at the Norwegian oil fund, it's solely invested abroad. And there are good arguments for diversifying further out of Iceland. And this mandatory and voluntary pension scheme is the third largest now in Europe in terms of GDP per capita. But this is actually probably the fastest growing as well, because we have now between 15.5% to 20% of salaries going into the scheme every month. And the demographics are still very favourable, so you won't see outflows exceeding inflows for most funds for the next 12 to 15 years.

And it's not only public discussion. I mean, the central bank governor came out on this. So it's gaining momentum.

Great. Thank you very much. I'll hand it over.

Thank you. Once again, if there are any further questions, please dial 01 on your telephone keypads now. And we've got a follow-up from Martin of Geltenstedt. Please go ahead. Your line is open.

Yes, hi again. Just one follow-up question in terms of capital return. Could you just clarify, if you were to do another buyback, do you still require an EGM approval for that, or is that within the authority? So essentially that a buyback would only be subject to central bank approval, as opposed to dividend, which I think, to understand, would require an EGM. Thank you. Yeah.

So we obtained an AGM approval in our last AGM for a permission to buy back up to 10% of our own shares. And in April, we canceled 70 million shares. So we currently hold around 3.5% or 3.4%. of our own shares. So the only kind of approval that we need is an approval from the regulator. In the case of buybacks, we do need that approval. And then just a board approval, obviously, to reinstate a buyback program.

Very clear. Thank you.

Thank you. Once again, if there are any further questions, please dial 01 on your telephone keypads now. OK, as there seems no further questions coming through on the phone, so I'll hand back to the speakers in the room.

Thank you very much for joining us for this presentation and for your good and comprehensive questions, Martin and Johan. And we'll see you again in three months' time. Thank you.

Thank you.