Arion banki hf.

Good morning all and welcome to a presentation of our first quarter results. My name is Benedikt Gislason. I'm the CEO of Arion. And now starting with the results in the first quarter, we're pleased that we received or met all our financial targets in the quarter. 13.7% return on equity on a leverage ratio of 11.3%, which is a pretty good outcome. If you look at the cooperating income against risk exposure amount, We posted one of the highest quarter that we've done, 6.9%. That compares to 6.2% in 2022, same quarter, and 6% in 2021. And this is, again, driven by another quarter where we see positive momentum in core income. For the quarter, we saw 18% increase between years for core income. And what is also interesting to note note around this is that due to our capital optimization and buybacks of shares, we have seen a notable increase in earnings per share over the period. And just to give you one figure to digest in the first quarter of 2021, Our earnings were some 3% lower than in ISK terms than in this quarter, but the EPS number in this quarter is 20% higher. So earnings per share growth is continuous in our business. And talking about our capital optimization plan, our capital and dividend strategy, we remains unchanged, but we will nevertheless remain cautious and focus on maintaining our robust position in these challenging times. Now, in this quarter, we had two changes to management, which I think is relevant to mention here. We're pleased to have on board two very experienced managers. Björn Bjørsson, he's joining us from Boston Consulting Group, heading our information department. ...technology operations. And then a new CEO for Vörður, Guðbjörn Keida Guðmundsdóttir. He's joining us from Marel. Again, two very experienced managers who will strengthen the team further. I think it's worth talking a little bit about the economy, because we are in sort of challenging times, but at the same time it's really, really good to see what our chief economist, which will turn on the stage after me, I think she labeled this as the fourth pillar of our economy a few years back, and it continues to grow. It's the IP intensive or knowledge-based industries that continue to deliver on export growth and job growth in our economy. And I think it's worth mentioning this again, as we saw yet another strong year for this industry. And that is on the back of what is now expected to be a 30% growth in our tourist industry. And one might ask, how does Iceland cope with this? Well, we've enjoyed strong immigration in the past year, year and a half. And last year, as Altnaberg will discuss in her presentation, In her presentation, we saw the highest population growth in our economic history since records were kept in 17-something. And this continues in the first quarter again, and I think the population growth now is measured close to 4% for the past 12 months. And that is obviously... Luckily, easing a little bit the strain that we've seen in the labor market, but at the same time, the supply-demand picture for the housing market remains then challenging as we see influx of talented people to our country. This concludes my part of the presentation. I welcome Erna Björk, Sverre Stotir, our Chief Economist, to the stage.

Thank you, Bendigt. Good morning, everybody. It's great to be with you all here today. As you might have noticed, this is the last time I will stand on this stage for quite some time as I'm going on a maternity leave, doing my part to maintain the population growth here in Iceland, as Bendigt mentioned. Not that it needs any help. The population increased by 11,500 individuals last year. 3.1% population growth. And as Ben mentioned, this is the largest increase since 1734, which is when our records began. Now, the population continued to increase in the first quarter of 2023, increasing by just over 3,000 individuals. Now, I might wonder why... Iceland, and why is this population growth here in Iceland? And I can tell you right now, it's not the baby boom like we had in the pandemic. People are not moving here for the weather. It's to work here. It's to work in the tourism industry, in construction, or in the intellectual property sector, as Ben mentioned before. Of course, the recovery of the tourism industry has the biggest impact on imported labor, having just last year reclaimed its status as the country's largest export sector and one of the main drivers of GDP growth. According to preliminary figures from Statistica Iceland, GDP increased by 6.4% in 2022. So in line with our expectations, but it is a significantly stronger growth than our main trading partners experienced. Now, as I said, tourism played a vital part, but its contribution to GDP pales compared to private consumption, which increased by 8.6% between years. So as you can guess from this figure, the fourth quarter provided yet another record-breaking private consumption figures. So this means that even though the tourism industry is well on its way to reach previous highs, the contribution of foreign trade to GDP was actually negative in 2022, as imports increased more than exports, leading to a current account deficit for the second year in a row. Still, the deficit was slightly smaller than anticipated, and it could improve as tourism goes from strength to strength, although I don't expect a surplus anytime soon. But the year is, it is certainly off to a great start. 420,000 tourists visited the country in the first quarter, 71% increase between years, and 87% to the first quarter of 2018, which still remains our largest year, our biggest year in tourism to date. According to the leading airlines flying to the country, the outlook is still very bright, despite the challenging operating environment, with strong demand for travel and significantly higher bookings for the next months compared to last year. Therefore, we have revised our tourist arrival forecast upwards, now expecting 2.2 million tourists to visit the country in 2023, a 30% increase between years. So overall, the Icelandic economy is set for a very strong growth in 2023, despite the rocky global recovery. According to the IMF's World Economic Outlook, which was published just last April, Iceland will have one of the highest GDP growth in advanced Europe in 2023. Domestic analysts are even more optimistic, with a consensus currently at 3.3% growth in 2023, followed by a 2.8% growth in 2024. Now, I know this might sound a bit optimistic, especially given the global turbulence and the headwinds facing financial institutions. But I believe due to the strong figures we have seen in the first quarter, that the forecast will continue to be revised upwards as the year goes on. Icelanders' payment card turnover increased by 8% between years in the first quarter of 2023, adjusted for inflation and exchange rate. These figures indicate a much stronger private consumption growth than most had dared to hope for, I believe, partly due to substantial wage increases, a tight labour market and significant household savings. Our savings ratio has remained high and is still well above its pre-pandemic average, which means that households can maintain a higher level of spending than most had previously thought. In addition, the labour market is tight. Unemployment measured 3.8% in the first quarter and is expected to drop further as still significant labour shortage remains. And finally, wage agreements for The whole private market has been signed, the last union signed in the first quarter, and these agreements, which provide generous wage increases, have been used and are being used as a benchmark for other agreements, for example in the public sector. So private consumption will definitely continue to play a vital role for the economic growth, which is somewhat problematic for the Monetary Policy Committee of the Central Bank, which is trying to cool the economy in order to get inflation under control. What the MPC is currently concerned about is taming inflation before the upcoming wage negotiations to achieve visible results, as the governor put it, to prevent a wage price spiral. The current agreements, they are short-term, they expire in January 2024, and they are not consistent with the central bank's 2.5% inflation target. So the MPC certainly has its work cut out for it. So far, we are not off to a great start, as inflation has proven to be much more persistent than anybody expected, measuring 9.9% in April. Price increases are becoming more widespread, inflationary pressures are still growing, and long-term inflation expectations are still rising on some measures, and they are well above the central bank's inflation target. And this has compelled the MPC to take drastic measures, increasing interest rates by 100 basis points in March and indicating another large step later this month, with analysts and market participants now expecting around 75 to 100 basis point rate hike later in May, taking the key interest rate well above 8%. So far, the most visible effects of the rate hikes have been on the housing market, which is rapidly cooling. The year-over-year change in the capital area is still positive, currently at 11% compared to 24% a year ago. But with this less activity in the market, increased number of properties for sale, rising interest rates, and of course the central bank's imposition of borrow-based measures, the year-over-year change is expected to continue to fall rapidly. Three months ago, I said into negative territory, but the latest figures indicate, or they strongly indicate, that the housing market is more resilient than I expected, with the three-month change turning positive again in March. One other reason for this resilience could be the fact that households have responded to the rate hikes by increasingly moving into inflation index mortgages, which have lowered debt burden at the start of the credit period. Other important, and perhaps the most important reason, is this population growth that I mentioned at the beginning of my presentation. Even though housing investment is still very high in historical context, the population growth far outpaces the increase in number of dwellings. So we kind of find ourselves in a tricky situation yet again. We are battling familiar foes in the form of inflation, rising inflation expectations, but thankfully the economy is built on stronger foundations than previously, with debt levels relatively low, positive net international investment position, we have Apple FX reserves. So if we play our cards right, Iceland should be able to remain in an enviable position. That being said, I would like to welcome Olof Erhaskuldsson, our CFO, to the stage to go over the financials. Thank you.

Thank you, Erna. Good morning. So now I'll look more closely at the results in the first quarter and starting as I usually do with the key highlights. So first, a strong start to the year, 6.3 billion in net profits, and ends the quarter with an ROE of 13.7%. Again, as Benedict mentioned, the result is driven by ongoing momentum in our core income lines, which have increased by 18.3% over the past year. Second, the net interest income grew again in the quarter, and the net interest margin held at a robust level of 3.1%. Third, another very strong quarter in terms of fees and commissions, with total fees of 4.4 billion, with all fee-generating businesses delivering a very strong quarter, and especially so with CIB and asset management. And fourth, importantly, our capital funding and liquidity positions remain solid in terms of liquidity. Our LCR ends the quarter at a very strong level of 174%. And again, importantly, our 125 billion liquidity portfolio is all short duration. And all these bonds, in light of the recent discussions globally, all these bonds are accounted for at fair value with all mark-to-market movements going through capital. Our deposit base is robust and well diversified and grew by 2.6% in the quarter. And our wholesale maturity profile remains light over the coming years. over the coming year. The capital position continues to be very strong, with a common equity tier one ratio of 18.6%, and as Benedict mentioned earlier, we aim to manage this conservatively near term. So now looking more closely at the results of the quarter. Operating income was 16.3%, or 13% up from the first quarter of last year, and 5% up from the last quarter. Operating expenses were $7.2 billion, and these were somewhat impacted by one of items which I'll discuss later in the presentation. Net profit, again, $6.3 billion, and an REO of 13.7%. And now I'll go through sort of the key line items in more detail. Starting with net interest income, which again grew in the quarter and has increased by 16% between years. As before, we continue to be cautious as to guidance around the margin going forward, and expect to see this trend down to the 3% level over the medium term. With the higher policy rates, clearly competition and customer focus increases around deposit rate. We aim to continue to be competitive in what we see as stable deposits, which we define as deposits from core clients, which mostly have multiple products with a group, and then in terms of term deposits. Over the near term or the medium term, cost of borrowing is likely to increase when we refinance upcoming wholesale maturities. Countering this to some extent will be the positive impact, especially into next year, of the fixed rate mortgage resets on that portfolio. So in terms of fees and commissions, the momentum from last year has continued into this year, and we had a very strong quarter with 4.4 billion in fees. In general, like I said, all fee-generating businesses delivered very strong results, asset management and CIP especially so. Again, the group gains from having very good diversification in its fee-generating businesses, with all gain from having a strong and relatively stable market position. In terms of insurance business, the results follow a similar pattern to what we saw last year. We are pleased with the growth momentum in the business, and premiums written were just under 16% up from the first quarter of last year. The high claims ratio over the past year is, however, higher than we would like it to be. It should be noted, of course, that the first quarter is always a historically difficult one in the Icelandic insurance business, mainly due to weather seasonality, but we would still like the claims ratio to calm down. The business has been restructured significantly over the past year and during the quarter we also had a new CEO at Vörður. All these changes have been focused on strengthening the platform for growth and this will over time build scale, resilience and competitive ads in this business which we are confident to continue to drive strong profitability. NatFinancial income was positive in the quarter both for equities and bonds following challenging quarters recently. Again, in terms of our liquidity portfolio, it is worth highlighting that we have no healthy maturity accounting in this portfolio. All market-to-market movements are incorporated in the capital position. And again, this is a very short duration portfolio with an average duration of that bond portfolio within one year. Moving on to operating expenses, we are generally content. with how we see this being managed within what is, of course, an inflationary environment. As I mentioned, it should be noted that there is some noise in the numbers in this quarter, especially with one-off items both in salaries and other operating expenses. Within salaries, we have 120 million charged in the quarter related to the labour agreements, which were partially backdated in November-December, which is accounted for in the first quarter. In other operating income, we also have around 200 million in items, which we do not consider as usual going forward cost items. Despite of these, we still close the quarter with a cost to core income ratio of 47%, which is in line with our targets. Moving swiftly along to the loans to customers, we did see a growth in the quarter of 2.7%, which was driven by the corporate side in this quarter. In terms of the overall market, I think it is fair to say that the market side of the business has slowed in response to the central bank's actions. And the corporate sector has been more active, but our base assumption is that this will slow somewhat near term as the rate hikes impact corporate activity going forward. Our aim, as always, is to remain agile in this environment. We removed our loan growth target at the start of the year, but we have a very well diversified business and are in a strong position to allocate capital where we see opportunities going forward. The loan growth continues to be very well balanced, 47% in mortgages, 6% in loans to other individuals, and 46% to corporates. So I wanted to just stop briefly on mortgages specifically. It's a book that comprises 520 billion in our loan book. And as we have previously highlighted, the bank has been very proactive in managing this book, considering the changing rate environment. In addition to the macro prudential measures set by the central bank to limit leverage in the market, we have also made specific changes to our credit assessment in order to strengthen the portfolio. Clearly, these measures have contributed to a slower growth in the portfolio in recent quarters. Over recent years, the non-indexed products have driven growth in this area and now represent around 59% of the mortgage book. Roughly half of this is floating rate and the other half is fixed for up to three years. We anticipate that this dynamic will shift, as Ertan mentioned, over the near term and that CPI-linked mortgages will gain popularity again, given their general lower payment profile. This is especially the case when expected to materialize when the non-CPI linked fixed rate mortgages are reset over the next couple of years. We have provided a stress test on this set of borrowers, the fixed rate non-CPI linked borrowers group specifically, and based on our stress test, the majority of those borrowers could still refinance into non-CPI linked fixed rate mortgages at the current rates. But clearly a part of those borrowers will be moving into CPI linked at least partially. We are very confident in the resilience in this portfolio. Over 86% of the exposure is to mortgage borrowers with an LTV of below 80%. And over 87% of the total loan portfolio is below 55% LTV when splitting up the individual loans. So I wanted to also stop briefly on the real estate exposure in our corporate loan book. Clearly, this is a sector that has been a focus globally from investors, so I thought it would take a couple of minutes to go through our portfolio. Overall, the real estate-related lending in our corporate loan book comprises a total of 105 billion kronas, around 9.5% of our loan book, and the average LTV of the portfolio is 66%. It is very important to note, however, that the underlying profile of these loans varies considerably. The bank's portfolio in this regard is highly diversified. Over 50% is towards SME retail exposures and mostly towards clients that own the operating and real estate companies within the same group. And where the group's operating companies is the tenant of the property. Around a quarter of the portfolio, or 28 billion, is related to residential properties. Exposure to office real estate is small, or around 12 billion, or 1% of the loan book. It is also worth noting that more than half of this portfolio, the office portfolio, is financing office real estate that has long-term lease contracts with the government institutions. So moving on to our provisioning position. Total loss allowance at the end of the quarter is 0.6% of the loan book. During the quarter, we have, again, conservatively reflected worsening economic outlooks in our IFRS 9 assumptions, where we increased the likelihood weights of the pessimistic scenario. We have, however, had some countering movements in the quarter, including the revaluation of collateral and expiry of forbearance exposures, which results in the net 52 million in provisions in the quarter. We continue to see that through the cycle, expected loss of the loan book of around 20 to 25 basis points, based on the current loan book competition. So in the quarter we saw deposit base grow again by 2.6%. As we have been expecting and guiding for over the past year, the policy rate hikes globally have impacted deposit markets globally. This manifests itself firstly from the fact that deposit rates are now clearly higher in general across the board and thus our clients become more focused on this product and the deposit betas rise. The second level impact of this becomes a more dynamic flow of deposit, and especially for some types of deposit clients. This is a global trend and should not be surprising. The digital revolution in recent years further supports this trend. From this has then come the realization from the market that all deposits are not created equal. both from a regulatory and a stability perspective. We have been very much prepared for this dynamic, and expect this to be a continued theme in the sector near term. In this regard, our clear strategy has been to be competitive in the market for what we see as stable deposits, and less so in more volatile markets. The group gains from a strong client group which has been built up over decades by Arian and its predecessors. In most cases, we have a multi-product and long-standing relationship with our deposit clients. The deposit pool is well diversified and robust. 42% of the total deposit base is insured by the Deposit Guarantee Fund and around 80% of deposits from individuals. So moving on to our wholesale funding, during the quarter we were active in ISK covered market and Scandinavian private placement markets, issuing small senior preferred bonds in lock and sack. As highlighted, we have a light maturity profile over the coming year, which allows us to be flexible in terms of issuing plans near term and in terms of pursuing profitable growth opportunities. We have a Euro senior maturity in May 2024, which we'll be considering refinancing early in the coming months. So looking at capital, our position remains very strong despite taking large steps in capital optimization over the past year. Our common equity stands at 18.6%, which is a 270% basis points management buffer above regulatory minimums. This position includes a foreseen dividend payment corresponding to 50% dividend payout ratio and includes the full impact of the ongoing buyback program. The non-risk-weighted measure of capital, the leverage ratio, of course, remains at one of the highest in Europe at just under 11.5%. We will be considering options for optimizing the 81 allowance that we have in our capital stack, but clearly this will be market dependent. In terms of MREL, we currently have 9% buffer above the 23% minimum in terms of risk exposure amount. This will be lowered by around 4% to 5% later this month when the €300 million senior issue maturing in May 2024 is within one year of maturity. So before I hand over to Q&A, just finalizing on some final thoughts going forward. So we conclude a strong quarter and a positive start to the year. We continue the operating momentum from the past couple of years. As is always the case, we face an ever-changing external environment. We are in a very good position to navigate this successfully. The Icelandic economy, as Erna mentioned, is robust and is set for healthy growth this year. The economy is in a good position to navigate the key challenges, which continue to be the current inflationary pressures and the global market volatility. Our liquidity and funding positions of the group allow for flexibility when it comes to funding position going forward, which is important in the current environment. Agility and long-term perspective continue to be the key in the current environment. The group is very well diversified with business units which are profitable and have a long-standing market position. This is a very good position and allows for agility when it comes to capital allocation going forward. And while we have a general positive outlook, we, of course, continue to take a conservative view when managing growth, provisioning, and capital positioning, considering the current market backdrop. So thank you, and I would like now to move over to Q&A and hand over to our head of IR, Theodor Frippeson.

Thank you and good morning everybody. I believe we have some questions already from our online participants, so we'll start with those. And the first questions come from Maria from Citi. And we'll start on how do you see the NII developing in the coming quarters?

Yeah, I think Olaur sort of reflected a bit on that in his presentation. As we mentioned in previous quarters, there is clearly going to be pressure on the deposit margin as policy rates move higher, and I think this pressure increases with higher policy rates as people become more kind of deposit rate sensitive and the awareness raises. So we previously guided for a range of

We're guiding to around 3%.

Yeah. Yeah. So we are 3.1 now, and so we're expecting this to normalize at a slightly lower level.

I think in the short term, of course, the rate hikes from the central bank have been greater than we were expecting. And we are balanced in such a way that, of course, rate hikes do deliver sort of short-term impact because more of our asset side of the balance sheet is floating than the liability side. So there's potential for near-term positive impact if the rate hikes continue. Then in the longer term, as I mentioned in the presentation, there is the dynamic around the fixed rate mortgages. So there will also be a positive uplift there when those get reset, mostly in 2024, but starting in the autumn this year.

And relating to this as well, can it defend margins at current levels given pressure on wholesale funding and deposit costs? Or is it going to be a challenge to sort of maintain the 3% NEM?

Yeah, it's going to be challenging when wholesale funding levels are where they are. But I think we can further deploy the flexibility in our business model. Three years ago, we adopted the kind of original to distribute approach. on the corporate side and we did some four billion in this quarter of kind of syndication of loan exposures and I'm sure that if funding levels remain elevated I'm sure that we will move more into that area as the pension fund system here in Iceland continues to grow, insurance companies and notably we've seen overseas interest in some of these exposures as well.

I think it's also important to note that, I mean, this group has been very, I mean, our name has been very stable through the low interest rate environment, the high interest rate environment. I mean, through the cycle, we've managed to retain a very stable net interest margin, around 3% level historically. So that shows exactly what Benedict mentioned, that we have agility to move our capital occasion and respond and to retain this margin.

Secondly, on fees. Fees were very strong during the quarter, supported by several large CIB projects. What is the outlook for fees from lending and guarantees from coming quarters, recurring levels or project pipeline?

So the pipeline continues to be quite strong in this market environment, I would say. We were expecting an activity to decrease or move to a lower level, but there's still a lot of activity. There are companies contemplating to list on the stock exchange and and making investments. But this is obviously, as noted in Olof's presentation, 75% or close to 75% of the net fee and commission is coming from corporate activity. So it's very dependent on corporate activity to continue. But if the economic forecasts play out, as we As Erna was reflecting on, 2-3% real growth in our economy for the next few years will represent corporate investment and probably public investment as well.

Then finally on the OPEX, two questions there. The OPEX growth, even excluding one-offs, was higher than anticipated and above inflation. What is the amount of planned IT investments this and next year?

I mean, I don't think we have a sort of set number that we're getting there. I think, as we mentioned in this quarter, we had these one-off items earlier, We are in an inflationary pressure. It's a challenge for everyone operating in this environment to keep costs down. I think we have a track record of doing that quite well. So I think that's probably the answer for now.

And how do you see the full year 23 cost growth? And what are you doing to offset some of these cost pressures?

um i mean we're constantly reviewing uh all costs uh items and um but i think it's it's also very important to um sort of have the ability backed by strong capital generation to invest into our business and and uh with this kind of population growth and and and kind of the robust economic outlook, you know, we see opportunities by investing in our business to build for kind of more extensive business offering going forward. But, you know, we stick firm to our core cost income ratio of 48%, and it was good to see, despite the cost pressure in the first quarter, that we are below that target.

I mean, I think you should be looking at the quarter excluding the one-offs as sort of the near-term quarterly, but with the caveat of, of course, this is dependent on the inflation and labor agreements and such as well in the near term.

And this concludes the questions from online participants, so we move on to the auditorium. Any questions from the auditorium?