Arion banki hf.

Good morning to you all and a warm welcome to our presentation and webcast of our fourth quarter and full year results for 2023. My name is Benedikt Gislason, I'm the CEO of Aerion and here with me today to go through the results is Oliver Høskundsson, our CFO. It's never a dull moment in Iceland. And as we go through this in our headquarters here, we've had the sixth eruption going on at the Reykjanes Peninsula. 60 eruptions since the fire started in 2021. And we will be going through the impact of those to our credit portfolio and the economy and some other details of our results. To begin with, it was a good year and we met all our key medium term targets in 2023 with a return on equity for the full year of 13.6%. The only The kind of financial target that we're not meeting at the moment is a nice one to have. We are grossly overcapitalized at the moment, way above our financial targets, which will enable us to normalize our capital structure further in the coming quarters and years. Here are some of the key milestones of the year, and I will go in more detail in some of those later in my presentation. It was a nice event to receive the Bankers Award, the Banker of the Year, for the third year in a row now. We enjoyed strong momentum in all our business lines, and we've come a long way with our main distribution channel, the digital channel, the banking app, which has been voted the best banking app in Iceland now for seven years in a row. And many of our core products are mostly now sold through that channel, as you can see here. Strong momentum in our markets business. We continue to have a leadership role in equity markets. And we were involved with all of the listings that happened last year in the exchange and continue to... have a leading role in building up our capital markets, a role that we have played strongly and seen the importance of being an instigator in since the great financial crisis. And the bank assurance model continues to deliver above market kind of premium growth. And Werder continues to build up its portfolio and diversify it. And Ola will go in more detail through the numbers of Werder. Now, it was a positive event late last year when we received a ratings upgrade or Moody's initiated rating for our covered bond, where we are on issue globally through our EMTN program. And this is the highest-rated debt instrument in Iceland at the moment, as you can see here, three notches above the sovereign. And our advisors tell us that this will substantially broaden the investor base of our cover bonds. So very positive news. On the ESG front, we've made strides. This is the second year in a row that we've calculated the carbon emission from our loan portfolio. And this we use to assist our clients in assessing new investment that can further reduce their carbon emission. And we obviously have the objective of being net zero by 2040, in line with Iceland's targets. And as you can see on this slide, we have obtained two ratings, which rank us favorably compared to our peers, both locally and internationally. This is a project that we're really, really proud of and was launched at the beginning of the year. Women invest. Why did we launch this project? Currently, as in many or most economies, women are underrepresented when it comes to investment and finance. This is a long-term project. which we kicked off, as I said, in the beginning of January. And this is a long-term project where we are educating women on investments. pension tax returns etc and in the three weeks now three weeks into the project over 600 women have already attended seminars and in february for example we have four seminars scheduled and the schedule goes into the year and into next year actually And the objective is, of course, to increase women's participation in financial markets and contribute to economic empowerment and thereby life quality. A quick reminder on our Kevlar Markets Day on the 1st of March, where we'll go through our key strategic initiatives, the outlook, economic outlook, the outlook for the bank, and we will review some of our medium-term targets. This will take place here in our auditorium and will be streamed live. So please save the date. Now, on to the economy. We had a policy rate decision yesterday where the central bank decided to leave policy rates unchanged. But the tone has softened and we've most definitely reached terminal rates, policy rates, as the economy is slowing down and cooling. And it's notable to see that private consumption has really increased. The central bank took down its economic forecast for the year to 1.7 percent. The previous forecast was 2.6. And I think this all plays very well into an environment where we can start seeing inflation coming down further, policy rates moving lower. And we have hopes that the ongoing collective wage agreements will be supportive for that journey. What is also good to see is that when it comes to tourist arrivals, we have effectively reached the pre-COVID levels. And we saw a strong current account surplus in the quarter, which is going to support the exchange rate. As I said, inflation is on the decline and the collective wage agreements, which are ongoing, or the negotiations, have the aim of supporting that trajectory. And if successfully negotiated in the coming weeks, we might see the central bank starting to respond by lowering rates. Now to the volcanic activity in the vicinity of Grindavík, where we had an event this morning. As I said, the sixth eruption. Here you can see our credit exposure to the area, which is 10.3 billion. It's secured by collateral. A bulk of it, or a majority of it, is actually secured by fishing vessels and associated fishing quotas. ...which is not impacted by the events. There are real estate, commercial and residential in the area that we have exposure to. And we know, and this has been publicly communicated by the finance minister, there are ongoing dialogues... ...on a resolution for the residents of Grindavík to resettle at least temporarily elsewhere. And we are part of those negotiations as other markets lenders in Iceland. And we expect the outcome of these discussions to be presented in the coming days. And obviously this is a significant event for the area, Grindavik, and it's impacting livelihood and corporate activity in the area. But in the context of Iceland's economy, this is something that we as a society are fully capable of dealing with. There is a natural catastrophic insurance fund that will cover any damages from volcanic activity. And maybe it's a good thing as well that the residential real estate market has been cooling off. quite dramatically in the last quarters. There is enough supply of housing to cope with this situation. There is, speaking of housing, the housing prices are a component in the consumer price index. And this is somewhat unusual to how Western economies do this. So we have calculated an imputed factor from real estate prices. ...which is not done elsewhere. And there is now a discussion, open discussion, about changing the calculation. And here we show you the impact of making that change from a historical standpoint. I think the rental market in Iceland has developed... ...in a way that there is now more flexibility in actually calculating this from the actual rental prices... ...rather than the imputed real estate prices. And this is yet another argument for looking at the core inflation... ...and acknowledging that the measured inflation is somewhat higher than the true core inflation at the moment... And with that, I'm going to hand over to Oliver Høskundsson, our CFO.

Thank you, Benedict, and good morning all. So now I'll look more closely at the results for the quarter and the year, starting with the key highlights. So we conclude another solid quarter with a return on equity of just under 13%, which completes another strong year for the group with an ROE of 13.6% for the year. Again, the result continues to be driven by good momentum in all our key businesses and core income streams. And during this quarter, we also saw a good recovery in our investment income, which has been under pressure in recent quarters. Second, the net interest income again grew in the quarter, along with the net interest margin, which increased by 0.1% to 3.1%. We are now entering a new phase in the rate hiking cycle, whereby fixed rate mortgages have started to reset and restarted to reset during this quarter, which will be an impact to our NIM going forward and into this year. And this will be a tailwind for our NIM going forward. Third, the growth in the loan book has been slowing recently. And this continues in the fourth quarter. This is in line with our expectations and the guidance that we have provided to investors, considering the slowing economy and elevated rate position of the policy rates, of course. And finally, our capital liquidity and funding position continues to be very strong. Our common equity ratio, Tier 1 ratio, increased by 30 basis points during the quarter to 19.7%, and this includes the impact of a 50% proposed dividend payment. So now looking more closely at the income statement. Net profit in the quarter was 6.2 billion, and the net results for the year ended at just under 26 billion. Total operating income in the quarter was $16.3 billion, which is 11% up from the fourth quarter of last year and 9% up from the last quarter. Total operating income was $64 billion for the year. The core income lines, net interest, commissions and insurance grew by 2% between years. Again, as mentioned, financial income saw a good recovery this quarter with $1.4 billion in revenues after a number of challenging quarters in this line item. And now looking more closely at the key line items of the income statement. And starting with the net interest income. Following a reduction, slight reduction in this line item during the third quarter, we again saw increase in net interest income during the fourth quarter by 3% or to 11.3 billion. The net interest margin also increased and now stands at 3.1%. As highlighted in previous calls, there are perhaps two key themes to discuss here. First, as the size of the CPI-linked loan book increases, the fluctuations in the NIM are expected to increase between quarters going forward. This is because the CPI-linked lending will be impacted by the inflation print between months and quarters, which will create more fluctuations in the name between quarters. And this can be seen in the bridge at the bottom of this page, where you can see that the increased inflation between Q3 and Q4 resulted in a 500 million difference in net interest income between those quarters. The second theme that I want to mention is, like I discussed earlier, we are now entering a new phase in the rate hiking cycle, which will be a tailwind for our NIM into this year. As you remember, the first phase of the rate hiking cycle was, of course, the repricing of floating rate assets, which at the start of the cycle had a very positive effect on our NIM. The second phase of the cycle has been, over the past few quarters, the gradual increase in cost of deposits, which, as you know, in Iceland has been sharper than in many other countries. And this has been a headwind for NIM in recent quarters. During the fourth quarter, then, we entered into this, what I call the third phase of this cycle. we have the fixed rate mortgages which are around 150 billion of our loan book which have begun to reset and will be resetting in each of the next quarters and especially into the second half of this year there will be a partial counter impact of this of course from the fixed rate maturities of fixed rate cover bonds but the net result will be a positive impact on our name These factors will impact our NIM year term, but as before, we continue to guide to the medium term NIM of around 3% level for the bank. So in terms of fees and commissions, which were again strong in the quarter of 3.9 billion. This means that fees and commissions for the year were 16.4 billion, which are stable from last year, which was a record year for the bank. Fees for the year now cover 57% of operating expenses. And it's a demonstration of the change in composition of our income streams of this bank and the strategy that we've been working on that this number used to be 37% only a few years ago. As before, the diversity of the fee-generating businesses of the group supports good stability in this fee generation through the cycle. Assets under management grew and were just under $1,400 billion at the end of the year. So in terms of the insurance results, we are generally pleased with the progress of what continues, of course, to be a long-term strategic project for the group. In terms of the top line, revenues were up 15% between years, and the robust historic growth of this business is demonstrated by 11% annual growth on average in the last five years. The combined ratio for the year entered at 97%, which is higher than we would like it to be, which is up from 93.3% for last year. A key recent impact here, which is a sector phenomenon, has been the higher number of fire insurance claims during this year. And this has been highlighted by some of our competitors in the recent quarterly results. The return then on the investment portfolio, of course, of Vörður has been challenging in the past couple of years. This has meant that the return on equity of Vörður has been below our targets for the past couple of years. We continue to see significant opportunities in this area, and we'll provide further update on the bank assurance journey and our capital markets day in 1st of March. So looking at operating expenses, it is worth noting that here we present total operating expenses for the group, which include the insurance operating expenses which are netted in the insurance income line in the income statement. Total operating expenses in the quarter were $8.7 billion, which includes a $1.4 billion incentive scheme provision. in the income statement. Total operating expenses in the quarter were then 8.7, which includes 1.4 billion S. This is then 4% increase in total expenses from the same quarter last year, which compares to an 8% inflation during the same period. We then conclude the cost year for cost-to-core income ratio of 44.7%, which is well below our medium-term target cost-to-core income ratio. So just looking at the balance sheet and starting with loans to customers, which grew by 0.8% or $9 billion between quarters. Growth in general has been slowing over the past quarters, along with a slowing economy and elevated rate position. Out of the total growth in the quarter, just under $5 billion is a result of inflation impact on our CPI lending and $4 billion from FX impact on our FX corporate loan book. The loan book continues to be very well balanced, 48% in mortgages, 5% other loans to individuals, and 47% to corporates. So now looking at our provisioning position. This has increased over the year to 0.74% of the loan book, from 0.6.3% at the end of last year. Impairments in this quarter were positively impacted by some single name state three and state three collateral positioning improvements. Increase in the loans to moratoria in the quarter are due to measures in Grindavik, which Benedikt explained earlier. And we are, of course, as Benedikt mentioned, monitoring this situation, evolving situation, closely. In general, however, apart from the specific exposure related to Grindavik, the theme is the same as I've described in recent quarters. We have seen a slight uptick in non-performing loans, which is to be expected in the current rate environment. But in terms of historical perspective, these are still low from any comparison. We continue to see through the cycle expected loss on the loan book of around 25 basis points based on the current loan book composition. So looking at deposits, they were relatively stable between quarters, a reduction of 1.7%. This decrease at the end of the year was effectively in the wholesale categories, where we have deliberately allowed expensive deposits to leave the bank. Total deposits now stand at 793 billion, which represents 60% of total liabilities. As we have discussed, our strategy in this area has been to compete especially in the stable categories of deposits. And as we have highlighted in the top right chart of this page, the growth during this year has been in these categories, reflective of the strategy. So moving on to wholesale funding, as Benedict mentioned earlier, we had another positive quarter in terms of our rating profile. Following the upgrade to A3 of our bank rating from Moody's, we received our inaugural AA2 rating from Moody's for our cover bonds. S&P then upgraded also our outlook to stable again following a period of six months on negative outlook from S&P. And these actions should, of course, support our wholesale funding efforts, and it has been very positive to see the trend of our secondary spreads in euro bonds in recent months, which have tightened considerably. It was also very positive during the last quarter that we issued a 9 billion senior issue in the domestic market during the quarter. This is the largest ISK senior preferred issue in the domestic market. And it's another very strong avenue of broadening our funding options, which should support our funding effort going forward. We have a very strong EMRIL position. The buffer is 8.5% above requirements. And we, of course, continue to be active in the funding markets, both in ISK and opportunistically in the euro markets in the coming months. Looking at capital, our position is very strong. Common equity ratio of 19%, which again increased by 30 basis points during the fourth quarter. The leverage ratio continues to be one of the highest in Western Europe, at least, of 12.4%. And this means now that our common equity ratio is 480 basis points above the regulatory requirements. And this includes, of course, a 50% dividend payout ratio assumption for the year. Obviously, as before, this is well above our medium-term targets of, like Benedikt mentioned, 150 to 250 basis points. And based on this target, there's roughly 15 to 25 billion of surplus capital above our management target, medium-term management target. However, of course, as discussed, our capital planning has been impacted by S&P, which increased their economic risk assessments of the Icelandic banking sector earlier last year. And this effectively, as discussed in our last previous quarters, increased our capital requirements for S&P thresholds by around 2.5% of risk exposure amount. It was good to see during the fourth quarter that S&P did move their economic risk score for the Icelandic sector to a positive trend. which does reflect a positive view of them potentially lowering the risk profile again in the next 12 to 24 months, which would again dramatically reduce our capital requirements from S&P perspective. As stated before, our expectation is that the rating agency and regulatory capital thresholds will convert over the medium term, which would allow us to optimize capital again to where we want to be over the medium term. So going forward, We conclude another strong operational year for the Group, exceeding all our medium-term targets. And this is despite, of course, an ongoing volatile external operating environment. The sharp increase in policy rates has started to have an expected impact on slowing the Icelandic economy, and this has, in turn, slowed the growth of our balance sheet. We are, however, seeing, as Benedikt mentioned, positive signs that inflation is starting to subside. which would allow the central bank to manage rates back down in the near term. And of course, the ongoing union waste negotiations, which hopefully get concluded in the coming days or weeks, will be a very strong milestone for the Icelandic economy to find a sustainable balance of the economy. Our diverse businesses and strong and mature market position in all key business units means that we are in a very good position to navigate the current external environment. And this is further of course supported by a very strong capital position, very broad and robust funding position, and conservative loan provisioning, as well as operational cost discipline. Of course, the volcanic activity on the Reykjanes Peninsula and the impact of the town of Grindavík continues to be a key focus for us and the rest of the Icelandic economy. We are working very close to our clients and authorities around this evolving scenario. And finally, of course, we hope to see many of you at our Capital Markets Day on the 1st of March, where we will be going deeper into our key strategic projects and the outlook for the group. So on that note, I thank you very much and hand over to Theodor Fredriksson to manage the Q&A.

Thank you and good morning all. Just wanted to remind participants online that they can submit questions through the platform. But as usual, we'll start with a couple of questions already submitted online. And starting with a question on the loan growth. During the last two quarters there has been a limited loan growth, both for corporates and individuals. What is your view regarding demand for new lending during the next few quarters, both for mortgages and corporate lending?

um yeah on the corporate side i i think we need to factor also in that in in last year especially in the second half of the year we saw sort of increased activity from lenders abroad especially in the seafood and aquaculture business So if you adjust for that, our underlying growth, meaning that we were subject to early repayments on our exposure to these industries, was actually somewhat higher than reflected in the loan growth figures. But what I find particularly good to see is that our focus on capital velocity and activity throughout the year and in each quarter is demonstrating itself in strong kind of feed generation. So our focus on originate to distribute is really paying off here. And I would argue that the loan growth measure is not as critical when it comes to feed generation as it was maybe for three four years ago so the activity remained strong in the in the last two quarters and and the outlook is is relatively strong as well so But this, I would say, demonstrates that this business model is actually working much better than having to rely on loan growth for generation of fee and commission income. On the market side, there is obviously the... The housing market, residential housing market, has slowed down somewhat. But our market share in that space increased somewhat in the second half of the year. And the outlook remains broadly similar for the year. So I think we will continue to enjoy single-digit, low single-digit loan growth on the market side. Anything you want to add?

No, I think you covered most of it. I think, of course, in terms of the headline, absolute loan growth, I think it will be, of course, the key impact. There is the policy rate trajectory and the growth in the Icelandic economy, where we roughly are similar to how that moves. But like you said, it demonstrates the strength of the strategy. that if you look at our fees in terms of lending fees and corporate finance in the past few quarters when loan growth has been limited, those have been very strong. It just shows that we are, you know, it doesn't look like we are, but we are actively rolling the book, and there is a lot of activity in the corporate lending space still.

Then secondly, the number of FTEs have been increasing in recent quarters and 5% from year end 2022. In which operations within the bank is this increase and what can be expected regarding development in expenses going forward?

Yeah, we always continue to look closely at the FT number, but the main thing is to have a kind of operational efficiency in all fronts. We have been adding to our headcount on the IT side as we continue to develop our distribution channels and invest into... new technology which is advancing quite rapidly these days and in the last few quarters and we expect to see further advancement of our digital services with the adaptation of AI for example and other tools so data is a huge focus for us at the moment and the kind of the The organizational changes that we introduced on Monday are actually very much kind of steered towards continue to building our strength in this area. But this is also, I would argue, a function and a factor of the momentum that our business lines are enjoying. As we highlighted in our presentation, we continue to add on assets under management. We continue to strengthen our position in corporate investment banking. And our bank assurance model is working well. And we're gaining momentum and market share in that.

Maybe. We are, of course, growing on the insurance side very fast, 11% growth on average over the past five years. And we have high ambitions there for further growth. So we are investing also in people, in the infrastructure there on the insurance side. So FTEs will be increasing in that area as well.

And we just received a question from Anton Berg from Koali. Hi, thanks for a great performance. Could you elaborate on your cost to income going forward? Is your target to be lowered or should we expect the cost income to increase? And secondly, do you have any insurance exposure to Grindavik or other affected areas?

Ole, do you want to take this? What was the first question? Yeah, cost to core. Yeah, I mean, I think, you know, we have our capital market stay the 1st of March. We'll be reviewing our medium-term targets here. We are, of course, well ahead of our cost to core income ratio currently. So that is something, of course, that we will be looking at. But I don't want to sort of jump the ship before the capital market stay on that front. Grindavik, we have some exposure there. But it's not material in any sense. And of course, as I think we have on the page, there is a natural catastrophe fund in Iceland, which is the key insurance entity with insurance in these scenarios, the housing, residential housing, at least. So the insurance company is not very limited exposure.

but on the cost to core income ratio as Ola pointed out there's been a positive trend and this ratio is obviously a calculation of underlying costs but also the development of our core income and our business strategy is obviously to grow the income line and at the same time keep costs under control. So this is something that we will be discussing in more detail in our Kaplan Markets Day.

Looks like this concludes questions from the online. Just got one additional from Luleana Golub from Goldman Sachs. Could you please touch on the trends you're seeing on the commercial real estate sector? Anything too noteworthy in the construction sector? And secondly, on funding, you mentioned plans for local and international issuance in 2024. Any plans for issuance in the senior unsecured format?

Yeah, if I touch first on the real estate sector, obviously we have hopes that the undeveloped area, the largest undeveloped area in the capital area, which we hold, Blikkastad, will be... progressing into development and we made some kind of strides in that direction with the local municipality and I think it's clear from both the Grindavik situation and just the fact that the Icelandic population is growing at a faster pace than any European country at the moment that kind of new development is required. And we see and hear from our clients that there are new projects being reviewed. And I think the momentum, especially in the residential real estate sector, will continue. and the capital area will be under development for probably decades and it's not long until we will see the population of Iceland exceed the 400 000 threshold and the forecast actually for population growth is has been under review and and is probably going to be raised on on the commercial real estate side uh which i think it's fair to say that we've seen a recent surprising development where where office space new office space is being developed we haven't really seen seen that happening for a long time now and and that is the sub component within commercial real estate that we were maybe had most worry about but seems like there's there's not our supply and and actually demand but when it comes to other sub sectors of the commercial real estate the the We're seeing strong activity there's not much inventory and And in some subsectors, there is even shortage. So there aren't any concerns with that portfolio. And our exposure there is covered quite well in our financial statement, the LTVs and the NPL position.

We have a page, I mean, it was in the presentation, but we have a page in the pack on the commercial real estate exposure of the bank. It's under 10% of the loan book. And as you can see on that page, it's very diversified. Only 1% is to office space. And like you say, it is a very different office sector here than you maybe see in the U.S. and the sort of regions where it's been a key concern. And it's also a very diversified portfolio for us. I think 40, just under 50 percent of it is to sort of SME clients, so small, you know, spread out to many, many individual counterparties. Yeah, so... The other question was funding.

On the funding activities in 2024, and any plans for issuing the senior secured format?

I mentioned we have a benchmark year on maturity at the end of this year and another one next year. So we'll be looking at all markets that we are operating in. It includes the Euro market and also the Scandi and now the domestic. It's good to have the sort of three avenues for those issues. But yes, we'll be looking at all those in the coming months.

We were quite pleased with the pricing in the local market in our issue there in the fourth quarter. So that broadens kind of the funding options for us considerably.

That concludes questions from the online participants. So are there any questions from the auditorium? No? I guess we can conclude the meeting then. And thank you all for participating and attending here. And have a nice day.

Thank you. See you on the 1st of March.

Yeah, 1st of March.