Arion banki hf.

Good morning, all, and a warm welcome to our webcast presentation of Arion Group's first quarter results for 2024. My name is Benedikt Gislason. I'm the CEO of Arion. And with me here today are Erna Björk, our chief economist, and Olavur Høskundsson, our CFO, who will go in more detail into the economic situation in Iceland and our financials. But let me start by going through the quarter, which were where the net earnings in the first quarter were below our target. Lower earnings during the quarter are mainly due to two things, weaker fee income and a 12 percentage points higher effective tax rate than what could normally be expected. Now, starting with the tax rate. The high tax rate is a result of a sharp market value change towards the end of the quarter on equity-forward contracts, when share prices of some Icelandic-listed stocks dropped materially. Our clients holding these derivative contracts had mark-to-market losses at quarter end and aryan mark-to-market gains. The mark-to-market gains are taxable for us, while our unbalanced sheet hedges with countering losses are not deductible. I think it's important to note that over a longer period, our equity forward business has contributed to lowering of the effective tax rate, and we anticipate seeing a reversal in the effective tax rate in this quarter. On the drop in fee and commission income, the economy is cooling off and economic activity has slowed down against a backdrop of higher interest rates. And this is one of the factors which has resulted in subdued fee income during the period. With policy rates at 9.25% and core CPI at 3.9%, the monetary policy has become very contractionary, as seen by real reduction in consumer spending over the past two quarters. And our chief economist will explain in more detail in her presentation. This was an unusually slow quarter in terms of deal-related fees in capital markets and corporate finance, which were down by around 30% from the average seen in the last six to eight quarters. But we are optimistic that the coming quarters will see a recovery in this area based on the activity that we're seeing and deal pipeline. On the positive side, we had our best first quarter in the insurance service results for a long time. where the first quarter is usually a seasonal low, and our net interest income increased by 2% between years. So despite a weak quarter in fee and commission income, our core income is only down by 2% from the same quarter last year and 4% from the last quarter. And we continue to be positive on the operational outlook of the Ariane Group and remain firm on our medium-term financial targets that we last updated in early March at our Capital Markets Day, where we also introduced a revision of our credit rating strategy, which has now been executed with selecting Moody's as the single rating agency for our issuance. We also discussed in our capital markets day our commitment of capital optimization, where we have now effectively distributed or committed to distributing around 18 billion to our shareholders through a dividend, a share buyback, which represents a little less than 9% of our market cap. In our Capital Markets Day, we also discussed the real estate market in Iceland. It's particularly pleasing to see a progress on that front, where Stepnir, our fund management business, launched towards the end of first quarter the largest Icelandic real estate fund to date. demonstrating its leadership when it comes to asset management for third parties. Since 2009, StepNet has now effectively raised $225 billion at current prices into private equity, co-investments on the private equity side, and private credit, structured debt, and now into real estate. And this fund opens up to a new and important asset class for the Icelandic pension funds, who are the main investors into this fund, as well as Stepney's asset management portfolio. And as you can see on this slide, the fund aims to drive development of new housing and to double the number of units owned by Halmstad by 2030. Another milestone in the quarter actually happened, sort of materialized this week, where we came out with the first pillar of our loyalty system, which we call Arion Refund. This is a reward system for customers of the Arion Group, tailored to the insurance business. What we're trying to achieve here is to increase customer satisfaction and loyalty, thereby hopefully reducing churn, increase cross-selling opportunities within the group, and better portray the actual value and convenience of having financial services in one place with Arian. And this is, as I said, only the first pillar of a loyalty system that will be built throughout the year exactly to meet those goals outlined on this slide. Very good to see this being launched. And with that, I'm going to hand over to Erna Björk Sverigeståttir, our chief economist. And she's going to go through the economic outlook and the economic forecast that she published earlier this week. Welcome, Erna.

ERNA BJÖRK Sverigeståttir Thank you, Benedikt. Good morning, everyone. It's great to be with you here today. It's been a while. I've been on a maternity leave, so I can confirm that even though we have apparently no idea how many people live in the country, we overestimated the population by 12,500 individuals last year. But at least I can confirm that the population did increase by one individual. And according to the latest estimates from Statistics Iceland, my little boy wasn't the only new Icelander, as the population increased by 2.3% between years. Now, population statistics are not the only statistics that have changed dramatically, as Statistics Iceland have revised GDP figures for the past four years significantly. According to the latest estimates, GDP increased by 8.9% in 2022, not 7.2% as previously estimated, making it the highest economic growth in over half a century. The first half of 2023 was also revised upwards, so the year totaled at 4.1% GDP growth, well above the central bank's expectations. And this change played an important part in the MPC's decision in last March to keep rates unchanged, even though there are clear signs that economic activity has lost pace. And that is something that was clear nine months ago. In the latter half of 2023, household consumption decreased by 1.8% between years, investment by 5%, and imports by 4.4%. Still, GDP managed to increase by 1.4%, thanks to fish farming, pharmaceuticals, but most importantly, tourism. Over 2.2 million tourists visited the country last year, just shy of the 2018 figures, which is still our biggest year in tourism so far. So with tourism back in full force and imports declining, the current account returned to a surplus amounting to 1% of GDP, a result that is well above analysts' expectations. Now, we expect this trend to continue for some time. That is, household consumption continues to give way while external trade fuels GDP growth. And according to our latest economic outlook, GDP will increase by 1.3% this year, a slightly lower growth than previously forecast due to a larger drop in household consumption. The IMF is a bit more optimistic, expecting 1.7% GDP growth this year, placing us in the middle of advanced economies, but well above the EU. But the year is definitely off to a rocky start, literally. We've experienced three volcanic eruptions in the first quarter. The last one is still going on today. And the global media coverage at the beginning of the year definitely impacted the tourism industry, with headlines like, Iceland declares state of emergency over volcanic eruption. This dominated the discussion, especially in January. So fewer people visited the country than expected and stayed for a shorter period of time. And this seismic activity may have a wider impact on the industry through the year, as travelers tend to plan their summer vacation at the beginning of the year, especially Americans, at least according to Google Trends. Still, as you can see here, we are moderately optimistic, expecting over 2.3 million people to visit the country this year. making it the biggest year in tourism, at least when it comes to the number of visitors. With revenues, they're still a bit lacking behind, as tourists are staying for a shorter period of time and spending less than before. And this is definitely a worrying trend that we need to focus on reversing. However, the tourism industry is not the only export sector on the rise. On the contrary, the opportunities seem to lie in the IP sector, pharmaceuticals, and fish farming, which have all experienced robust growth. And these industries are expected to grow significantly in the coming years, contributing a significant amount to total export growth. So the short-term outlook for exports is rather good, despite volcanic eruptions and no cable quota, but for domestic demand is a bit muddier. Investment is tricky to read. We are getting mixed signals from import figures, lending figures, and service in the first quarter. But when it comes to household consumption, the message is loud and clear. Icelanders' payment car turnover decreased by 0.4% between years in the first quarter, car purchases have fallen off a cliff, and Icelanders are traveling less abroad than before. So this means that household consumption most likely continued to decline in the first quarter, with our estimation at 0.5% contraction. However, despite the rough start to the year. We expect consumption to bounce back in the latter half of the year, thanks to wage increases and government's actions related to the collective wage agreement in the private market. And regarding this wage agreement, I'd like to note a couple of things. First, I think the government got the short end of the stick, forking out 80 billion ISK over the contract period. Second, it is a long-term agreement that runs through January 2028, which is a positive development that reduces uncertainty, hopefully creates a more stable environment for firms to operate in. And finally, the agreed wage increases are relatively moderate, at least in the Icelandic context. Monthly fixed wages will increase by 3.25% this year and 3.5% each year thereafter. It's a bit more tricky to estimate wage increases over wage scales. But overall, we estimate that the wage agreement is broadly consistent with price stability. However, the agreed wage increases, they only tell half the story, because they only provide the minimum wage increase. Because on top of that, we have wage drift. And the tighter the labor market, the more the wage drift occurs. And the labor market has proven to be remarkably resilient, with 3.5% unemployment rate in February, and firms scaling their hiring plans upwards again. So overall, we expect a notable wage drift, forecasting 6.5% on average nominal wage growth this year. And that is not consistent with the central bank's inflation target. And in fact, the MPC has voiced concerns that wage drift and fiscal measures in relation to the wage agreement could increase demand and inflationary pressures. Furthermore, house prices have risen in recent terms, despite the tight financial constraints with, of course, the people of Grindavik entering the housing market and expectations of rate cuts fueling demand. Still, inflation has been subsiding rather quickly in the past months, measuring 6.7% headline inflation on average in the first quarter, down from 10% a year ago. And we expected to continue to fall, averaging around 4.8% at the end of the year. But there is still a long way to go. Inflation is well above the central bank's inflation target. More importantly, so are inflation expectations, and underlying inflation has proven persistent. The NPC has stated that it needs an unambiguous indication that inflation is on the decline before they start to lower interest rates. And unfortunately, it seems that we're not there yet. With that, I would like to welcome Olaur Høskullsson, our CFO to the stage to go over the financials. Thank you.

Thank you very much Erna, and good morning all. So now just looking more closely at the results in the quarter, and starting with the key highlights. As Benedict mentioned earlier, it's fair to say that the NRECT results and the 9.1% ROE in the quarter is below our expectations. The headline figure, as he mentions, of course, is, however, largely impacted by two negative drivers, which we anticipate to recover over the coming quarters, namely the effective tax rate and the fee income. As he mentioned, the effective tax rate is very high in the quarter, or 38%, compared to a normalized 26% level. This is, as he mentioned, the result of a shock market value change in the equity forward contract with our clients. where our gain on the contracts is taxable while the loss on the equity holdings is not deductible. Second, the fee income in the quarter was unusually low, as Bennett had outlined. This is partly due to specific one-off items, including the reclassification of card insurance fees and the impact of our closure of the branch at Keplavik Airport. Countering this, our net interest margin, however, held at a very robust 3.1% level in the quarter and will be supported over the coming quarters by the resetting of the fixed rate mortgage portfolio as highlighted in previous presentations. And finally, and importantly, our capital liquidity and funding position remains very robust. And during the quarter, we, of course, reconvened our capital optimization efforts with the launch of an ongoing share buyback program. So now looking more closely at the income statement. Total operating income in the quarter was 14.5 billion, which is down 7% from the same quarter of last year. Net interest income increased by 2% between years, while we saw a considerable decrease, of course, again in fees and investment income in the period. Insurance, on the other hand, had an improved start of the year, while the first quarter is usually a seasonal low for that business. Operating expenses are increased by 1%, and impairments of 350 million in the quarter are primarily related to our mortgage portfolio in Grindavik, which of course was impacted by the recent volcanic eruption. And then as discussed, we had a very high effective tax rate again, 38%. And if we just compare that to a normalized rate of 26%, this effectively reduces our net income by around 800 million in the quarter. So that means the net profit was therefore $4.4 billion, which is down from $6.2 billion for the same quarter of last year. And now looking more closely at some of the key line items, starting with net interest income. Net interest income was $11.2 billion in the quarter, and the margin was unchanged at 3.1% level of interest-bearing assets. As highlighted in previous call, there are perhaps two key drivers that we want to focus on here. Firstly, I think it's important to note that the CPI-linked loan book has been increasing. And with an increased CPI imbalance, we are likely or we expect increased fluctuations in the NIM between quarters going forward. As the interest on those loans are reflected of monthly CPI prints, of course, which are dynamic. Secondly, of course, as mentioned earlier, we are entering a new phase in the rate hiking cycle where our fixed rate mortgage portfolio has begun to reset. This began at the beginning of the year at a slow pace and will pick up, especially from Q3 and Q4 this year and into next year. These factors will impact our NIM in the near term, but as before, we do anticipate that the margin will remain robust and around the 3% area over the medium term. So as discussed, fees were considerably low in the quarter, or 3.4 billion, which is lower than we've seen for some time. This is, as Bennett highlighted earlier, partially due to unusually slow three-month period in terms of deal-related fees in investment banking and lending, which compares to a very strong quarter, for example, in Q1 last year in this area. Capital markets and corporate finance fees were, for example, down by 250 million from the fourth quarter of last year. The other reason, as I mentioned earlier, are more idiosyncratic issues with combined impact of around 200 million. Firstly, we made the change in the accounting treatment of certain card insurance fees, which previously were included in fees, but will from going forward be included in insurance results. Secondly, in February, we then closed our branch at the Kaepernick Airport, and this reduces fees by around 100 to 200 million per quarter. On the other hand, of course, associated operating expenses will be phased out over a period. Overall, clearly, we are not content with this line item this quarter, following a very strong trajectory over the past couple of years. We are however confident and optimistic that the coming quarters will see a recovery in this area based on the business positioning and our deal pipeline. So looking at the insurance service results, where we had the best start of the year for a while. Due to the composition of the business, of course, you know that the first quarter is usually a low for our insurance business. The combined ratio in this quarter was 103.9%, which is improved from 115% area for the past few years first quarter results. Claims were considerably improved between years and the claim ratio was 85% compared to 92% last year. Growth continues to be robust in the insurance business and is tracking around the 13% level we have seen as annual growth over the past five years in this business. And just to conclude, the insurance business, of course, enjoys a unique position in the Icelandic market and has considerable further opportunities for growth and profitable growth. On that, moving on to the operating expenses, I think it's worth noting here that, and I keep mentioning this in every presentation, but on this page, we include the full operating expenses for the group. So this includes the insurance operating expenses. So it does not match fully the income statement. But the total operating expenses of this quarter was $7.4 billion, which is an increase of 1% between years. And this compares, of course, to an inflation in that period of just under 7%. Included in the operating expenses this quarter was a one-off impact related to operational changes, which is around $200 million, which is included in salaries. Of course, also, as discussed, we have closed our branch at the Keplervik Airport. which had the direct quarterly operating expenses of around 100 million, which will then be phased out over time. In general, we continue to manage expenses conservatively while maintaining our investment commitment as we highlighted and committed to it in the capital markets day in March. So just looking at the balance sheet and starting with the loan book. The loan pool grew by 2.2%, or $26 billion in the quarter. Growth has in general been slowing, of course, in light of the slowing economic activity and elevated rates. We did, however, see an increased pickup in growth on the corporate side this quarter, which is partly due to seasonality, but also due to a relatively healthy lending pipeline. Out of the total growth in the quarter, $6.3 billion is the result of inflation impact on our CPI-linked lending book, and around 1.5 billion from FX impact on our corporate loan book in FX. The loan book continues to be, of course, very well diversified, 47% in mortgages, 5% other loans to individuals, and 48% in to corporates. Looking at our provisioning position quickly, Total loss allowance at the end of the quarter is 9 billion or 0.76% of the loan book. Impairments for the quarter was just over 300 million. And as discussed, the primary reason for this was provisions related to our retail mortgage book in Grindavik, which has been impacted by volcanic activity in the region. These mortgages are provisioned in the quarter by just around 25%. In general, apart from these specific exposures related to Grindavik, the theme here is the same as I've described in previous presentations. We have and do see a slight uptick in non-performing loans, which is of course to be expected in the rate environment that we are operating in. But still, however, the size of this is relatively healthy from a historical perspective. We continue to see through the cycle cost of risk for this business based on the current loan pool composition. of around 25 basis points. So deposits were relatively stable in the quarter and increased by 1.2%. Total deposits now stand at 802 billion, which represents just under 60% of total liabilities. As we have discussed and highlighted in previous presentation, our strategy continues to compete, especially in the more stable categories of deposits. And as highlighted on the top right chart on this page, the growth of the past year continues to be in those areas. So moving on to wholesale funding and the credit ratings picture. As Benedict mentioned earlier, we did conclude our strategic review of our credit rating strategy as outlined in our capital markets day. The conclusion of this review is to focus solely on the Moody's rating going forward. And this conclusion, of course, as highlighted in the Capital Markets Day, follows a thorough evaluation along with external advisors around balancing our size, our issuance requirements, and, of course, the focus on the area bank investors retaining access to a highly credible credit agency going forward. In terms of issuance plans, we continue to access the ISK market regularly and will be reviewing optimistically the euro market in the near term. It has been very pleasing, of course, to see the spreads of the Icelandic banks tightening significantly in the international markets over the past few months. And in terms of MRL, our position is very strong. We have a 6% buffer above requirements at the end of this quarter. So looking at capital, our position continues to be very strong. Common equity ratio at the end of the quarter is 18.8%, or 350 basis points above the regulatory requirements. The leverage ratio, of course, continues to be very strong of the Icelandic banks, and our leverage ratio at the end of the quarter was 12%. The common equity position, of course, includes the foreseen dividend payment of 50% of net profits, and also includes the full impact of the 5 billion buyback program, which is currently ongoing. Obviously, this position is well above our medium term targets, which continue to be set at 150 to 250 basis points. which effectively means a common equity ratio of around 17 to 18%. Based on this target, we currently have a surplus of around 10 to 20 billion, which however, partially currently is being used for our tier one requirements as we are currently not fully utilizing the 81 allowance. It should be noted that the bank has outstanding warrants of around 53 million, which are currently in the money, and the final exercise window for those warrants is in August this year. Should all these warrants be exercised, we anticipate that the surplus capital will increase by around six billion. And of course, we continue to be committed to our capital optimization story. Well, of course, the pace of this will be evaluated at each time in line with growth projections of the balance sheet and evolving external conditions. So just before I hand over to Q&A, just highlighting some of the key themes going forward. We outlined in the Capital Markets Day a positive outlook for this group. And we, of course, retain this as I did outlined earlier. And this positive outlook is reflected in our updated medium term targets, which we increased in the capital markets day. The first quarter results are, however, below our expectations. But as outlined, we are confident that the key drivers for this results will recover in the coming months. Our diverse business and strong and mature market position in all key areas means that we are in a very good position to navigate the current evolving external environment. This is further supported by, of course, a very robust capital funding and liquidity position and the clear capital optimization commitment. And finally, while the inflationary and rate environment that's at an outland is, of course, a key challenge in the market, continues to be a key challenge, the Icelandic economy is relatively robust. And it is positive, of course, to see that the inflation is starting to subside. And as Adetina outlined, of course, it was a key positive that during this quarter, a large part of the private unions negotiated a relatively long term contract. So on that, I want to hand over to Q&A, where our head of IR, Theodor Fyrbjørgen, will manage the questions.

Thank you, Oliver. Good morning, everybody. Firstly, I would like to remind participants online that you can still submit questions through the online platform. But as usual, we'll start with questions from the online participants, and we currently have a couple of questions pending. So the first question is about the net CPI balance. In the past 12 months, the net CPI balance has grown quite fast, currently north of 100 billion. Does this concern you? How are you managing this? Do you think that this development will continue? And finally, how might it affect the NIM going forward?

Ole, do you want to take this?

Yeah, I mean, I think it's obviously a correct observation. I think for all the Icelandic banks, the CPI balance has been increasing over the past few months, as most of the demand on the loan side has been in CPI-linked format. This, of course, is a product that is very well known by Icelandic banks, and in general, Icelandic banks have historically operated a CPI imbalance of their book. So it's something that we know and something that we know how to manage. And how do we manage this? It's effectively in broadly two terms. Firstly, of course, we issue CPI-linked cover bonds, which provide a balance for our CPI components of the balance sheet. And we have a sort of natural demand for that product in terms of the pension funds, which have a CPI-linked investment requirements. And we continue to do it. We issue, effectively, core plans every month in CPI-Link format currently. The second way we manage this, of course, is through pricing. We are, of course, actively managing our pricing in the market, and this allows us to manage the, on how much of the lending we take on board. And, of course, what, and I think the pricing, what the pricing has done recently is that what's been happening is that the pricing on CPI linked mortgage has been increasing. and the non-CPI link more than the non-CPI link. So the difference between the two is decreasing, and I expect that might be what will be over the coming months. And when the difference starts to sort of decrease, I expect some of the demand to start flowing into the non-CPI link landing as well. So over time, the market will find a better balance. But I don't know if you want to add anything to that.

And you're referring to a difference in terms of the repayment profile of these two instruments.

Thank you. Then to the second question about the land development portfolio. Mindful about your message in the recent couple of markets day. Do you have any updates on the land development portfolio of the bank, i.e. what are the next steps expected?

Yeah, I think it's fair to say that the idea that we floated in our capital markets, they were well received and open up to discussions with companies and parties operating in the real estate space. The activity when it comes to developed land, especially in the capital area, is high. We've seen recent transactions at higher prices than before. And there is considerable interest in exploring the idea that we floated. And we're hoping to be able to share some more information in our next earnings call.

This concludes the questions currently from the online participants. So let's move over to the auditorium. Are there any questions? No? Nice and short. So I guess that concludes our session today. Thank you all very much for attending and see you next time.