Arion banki hf
ICEX:ARION
Earnings Call Analysis
Q3-2023 Analysis
Arion banki hf
In the latest earnings call, Arion Bank's CEO, Benedikt Gislason, highlighted the bank's sustained momentum with key operating targets met in Q3 of 2023. Despite the Icelandic economy showing signs of cooling, with loan portfolio growth decelerating to 0.8%, Arion focuses on capital efficiency and a diverse service range, allowing continued strong performance. The bank's partnership with Vordur, its insurance arm, bolstered success. Moody's rating upgrade to A3 reflects Arion's solid liquidity and capital resilience.
Net profit reached ISK 6.1 billion in Q3, contributing to a yearly total of ISK 19.5 billion and an ROE of 13.9%. Core income streams like interest, commissions, and insurance saw a 2% year-on-year increase. However, volatile capital markets challenged investment portfolio returns. Impairments edged higher but remained within anticipated cyclical norms. The Central Equity Tier 1 ratio improved to 19.4%, underlining the bank’s solid capital standing.
Q3 marked a shift in loan market dynamics with slower growth, especially in corporate loans, as a result of overall economic deceleration. Interest margin for the quarter slightly declined to 3%, impacted by lowered inflation and loan book growth. Despite near-term pressures such as high deposit costs, Arion maintains a medium-term net interest margin target of around 3%, suggesting continued robust performance.
Arion saw deposit growth of 3% from Q2, and a significant 9% year-on-year increase, with deposits constituting almost 60% of liabilities. The loans-to-deposit ratio now stands at 142%. The bank emphasizes maintaining competitive deposit categories to ensure stability. The strong capital position is evidenced by a 450 basis points buffer above regulatory requirements, indicating ample room for strategic capital allocation.
Arion announced the redemption of a SEK 500 million Tier 2 bond, asserting confidence in its robust total capital position. The bank ensures a conservative stance on capital management, with a sizable capital surplus despite S&P economic risk assessment adjustments. Going forward, Arion anticipates greater alignment between regulatory and rating capital benchmarks, reiterating confidence in Iceland's economic resilience. Investors can expect deeper insights into the bank’s strategic initiatives during the upcoming Capital Markets Day set for March 1, 2024.
Arion’s executives reaffirmed their ability to navigate the current market conditions, buoyed by conservative management practices and cost discipline. The bank's strategy also includes diversifying its insurance portfolio, particularly focusing on the corporate segment to build a more robust future business without increasing risk. The positive combined ratio trends indicate a competitive edge and healthy profitability, separate from market-side performance.
Arion is adapting to shifting customer preferences for mortgage products amid a highly refinancing-active market. The bank is balancing its net interest income and CPI imbalance, with mortgage product adaptations likely bringing more quarterly fluctuations. However, these adjustments are discussed as potential short-term improvements for the net interest margin (NIM), fostering bank profitability over the upcoming year.
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Good morning all. Thanks for attending, and a warm welcome to this Presentation of Arion's Q3 Numbers. My name is Benedikt Gislason. I'm the CEO of Arion. Following my presentation, you will hear from our newly appointed Chief Operating Officer before our CFO, Olafur Hoskuldsson, goes in more detail through the numbers. We will, as before, end the webcast with a Q&A session, which will be moderated by our Head of IR, Theodor Fridbertsson.And now to the results. There is a continued momentum in our business, and we achieved all our main operating targets in the first 9 months of 2023. During the third quarter, loan portfolio growth slowed down to 0.8%, reflecting easing economic growth in Iceland. Normally, we would welcome healthy economic growth, but the task at hand now is to reduce inflation and interest rates. So reduced tension in the economy is actually a step in the right direction.High interest rates impact households and companies in Iceland and consumption and economic activity in general have declined in line with the Central Bank's targets. However, despite the lower loan growth and less favorable economic conditions, our clear focus on more capital-efficient activities, capital velocity and broad range of services, which generate diverse revenue streams, combined with our focus on efficiency, delivered a stable and strong business in the quarter.One example of this is our bancassurance model, the partnership between Vordur and Arion, which has gone from strength to strength. Together, we are constantly seeking ways to integrate our banking and insurance businesses so that our customers can get the most out of the services that we offer.It was good to see an increasing number of customers, both retail and corporate, recognizing the benefits of doing business with both companies in this quarter. The Bank's capital and liquidity position continue to be robust. Factors which contributed towards the Bank's recent upgrade to an A3 rating by Moody's, recent positive outlook reviews on the Icelandic sovereign are also strong indication of the resilience of the economy.On capital management, we expect regulatory and rating capital thresholds to convert more over the medium term, which would enable us to continue normalizing our capital structure. At the end of third quarter, the CET1 ratio stood at 19.4%, 50 basis points increase in the quarter or 450 basis points above the regulatory minimum. And our LCR ratio was 179% at the end of the quarter with a short duration of our liquidity portfolio and no held-to-maturity accounting.And the final but very important message on this slide, please save the date for 1 March, 2024. That is when we are planning to have our third Capital Markets Day since we listed in 2018. It will be held in our headquarters in Iceland, where we will be providing an update on our key strategic initiatives and outlook.And now to the Icelandic economy. After a strong GDP growth in the second quarter, the third highest among the OECD countries, there are now clear signs of slowing domestic demand as seen in the payment card turnover and current account balance figures seen on this slide. The strong foundations of our economy, which have been gradually built over the past decade are intact, supported by robust export growth and healthy national saving rates. Leverage of households, corporates and the central government are low in historical and international context.Also, as we have pointed out before, you can see how much the fourth pillar of the Icelandic economy has grown in recent years. By the fourth pillar, we are talking about growing industries in Iceland with enough tourism energy officiaries related. This demonstrates well the increased diversity in Iceland's ability to generate export revenues, which should contribute to future growth and economic resilience.And this is where the value creation happens. With a ratio of 1 active company per 6 adults, Iceland exemplifies a culture of innovation and economic engagement. And in Iceland's active business landscape, Arion plays an important role by tailoring solutions and for diverse needs.On a group level, we have calculated that we have at least 1 touch point with close to 190,000 individuals or 50% of Iceland's population, and we are now actively seeking to build a broader business relationship with those customers through innovation and customer-first focus: a key strategic initiative that we will be elaborating more on in our upcoming Capital Markets Day.In the quarter, we continued to work with our customers who were facing higher financial costs as well as other increased costs. We have been reaching out to our clients and discussing the options with them. There are various ways of reducing the debt service. And we look into our clients' circumstances on a case-by-case basis and seek to find solutions together.In October, we announced organizational changes at the Bank involving the creation of a new division, Operation & Culture. The changes are designed to bring key units closer together, enhance operational efficiency, manage transformation projects more effectively and bring a clearer focus to service and customer experience.Culture and risk awareness are critical in financial institutions -- critical to financial institutions. The division will also play a pivotal role in the continued development and shaping of Arion Bank's corporate culture and the division will be headed by Birna Hlin Karadottir, who has served as the Bank's General Counsel since 2019 and has been a member of the Executive Committee since 2020.I now give the word to Birna Hlin, who delivers a recorded message to this conference call.
Good morning, everyone. My name is Birna Hlin Karadottir. I'm the newly appointed COO of Arion Bank, formerly the Bank's General Counsel since 2019.In late September, we notified the market of the establishment of a new cross-functional support unit called Operation & cultures. We have put together, in this unit, functions from the CEO's office, from customer experience and finance. This is now one of the largest divisions within the Bank and with around 130 employees.So why are we doing this? We live in a challenging environment. Naming a few factors there, we have this complex, comprehensive regulatory environment in the financial market, and we don't really see that changing materially anytime soon. We see changes in customers and employees' needs and behaviors, and we have a technology that is, as we all know, changing faster and faster. We want to stay ahead of all these challenges and changes and that's why we have to organize ourselves so that we can actually do that. And that's why we have established this new cross-functional division, and we are really embracing all of these challenges and even seeing them as opportunities.So we have put together human resources, business services, that is back and middle office and typical operational functions, legal services and transformations. And we are eliminating silos and we are actually thinking about how the backbone of the Bank and the COO can really execute the strategy in an efficient manner. And we believe that by doing this, we will achieve that. The transformation function will play a key role there and will drive leading operational projects throughout the organization, obviously, in really good cooperation with all other units of the Bank.We have culture now up there in the C-suite. And you don't really have to seek far in business literature to see that most of the experts emphasize that culture even plays a key role in -- for organizations to achieve their strategic goals. We are embracing that and we want to put focus and emphasis on this part of the operations. And we are -- by doing this, we are going to make our good corporate culture great and fully aligned with our strategy.The COO will consolidate support functions, providing central lead focused on delivering strategic goals, leading transformation, building strong corporate culture and thus creating competitive advantage by improving ways of working and talent management. We firmly believe that this will positively affect our business outcome, our risk mitigation, customer experience, employee engagement and attraction of new talent.We here in Arion, we have big ambitions. We have clear strategic goals. We are doing these changes because we want to move forward faster and more effectively. We are a leading company, and we are moving that path even more forward for customers, for employees and all other stakeholders.Thank you.
So good morning. So thank you, Birna, for a good introduction. And now looking more closely at the results for the quarter. So as I normally do, I'll start with the highlights.First, we concluded another solid quarter with a return on equity of just under 13%, concluding an ROE for the year of 13.9%, a strong result. This continues to be supported by the diversity and the maturity of our businesses combined with a conservative balance sheet management and cost discipline.Second, while the net interest income continues to be strong, we did see a slight reduction in this line item for the first time in a while. We expect the margin to continue to be robust, around 3% level, but we do anticipate more fluctuations going forward in the near term with foreseen tailwinds as well as headwinds, which I will cover in more detail on a later page.Third, the growth in the loan book has been slowing recently, and this continues in the third quarter. This is mainly generally driven by the slowing economy in Iceland, as Benedikt mentioned earlier, but also managed in response to the increased S&P capital thresholds, which were outlined in the last earnings call.And finally, our capital funding and liquidity position continues to be very robust. Our common equity ratio increased by 50 basis points during the quarter and now stands at 19.4%. It was then a very strong confirmation of our position to receive the upgrade from our credit rating of Moody's to A3 during the quarter.So now looking more closely at the income statement. Net profit was ISK 6.1 billion, which takes the net results for the year to ISK 19.5 billion and the ROE of 13.9%. The core income lines, net interest income, commission and insurance grew by 2% between years, but were below the second quarter. For commissions and insurance, especially there is some general seasonal effect here, but I will discuss this in more detail on later slides.Financial income continues to be challenging with the volatility in the capital markets continuing this quarter. This was impacted -- this has impacted our investment portfolio within our insurance business, but also our market-making business. Impairments in the quarter were slightly above last quarter at ISK 741 million, but cost of risk is still within what we see as through-the-cycle average.So now looking at more closely at the individual income statement lines. Starting with net interest income. In the quarter, as discussed, we saw a turn in what has been a continuous increase in interest income over the recent quarters with current -- within this quarter, both interest income and the margin slightly down. The net interest margin was 3% in the quarter and 3.1% for the 9 months.I think firstly, it's important to note that we will always have some fluctuations in this -- in the net interest margin and especially in a rate environment that has been evolving as rapidly as it has been in Iceland over the recent year. There is, for example, a timing difference between rate hikes on the asset and liability side, which always makes a comparison within a 3-month period challenging.But we also had some specific items in this quarter, which were headwinds for the interest income in this -- in the quarter. We did see a lower inflation in Q3 versus Q2. And with a higher CPI imbalance, the inflation impact between quarters is an increasing driver of our interest income between quarters. This was -- this meant a reduction of ISK 200 million between Q2 and Q3.Growth in the loan book has also slowed and especially on the corporate side. And this clearly means that growth in net interest income also is reduced. We also saw a significant inflow of asset deposits through our private bank during the end of the quarter. And this also has an impact in the short term on the margin.As we have discussed in previous earnings calls, we do see a tailwind for interest income over the coming year, especially from the reset of fixed rate mortgages. On the other hand, we have also seen headwinds from the cost of deposits, which have increased steadily over the past few quarters. With policy rates above 9%, this is to be expected and was anticipated by us. And we continue to focus on being competitive in this regard, especially in terms of stable deposit categories and term deposits. We see a stable funding source for the Bank in the long term.It is also to be expected that there will be more fluctuations as mentioned in the margin over the coming year. Firstly, this will be driven by the growth on the loan book, which has reduced as discussed. Secondly, because of the increasing impact of inflation, like I mentioned earlier, where the CPI imbalance is increasing between quarters. And thirdly, because of the timing difference of the fixed rate resets on the asset and liability side, which will be in different time periods over the coming year.But we do anticipate that the margin will remain robust. And as we have guided to in recent quarters, we expect this to be around the 3% level over the medium term.Commissions were again solid in the quarter at ISK 3.8 billion. The third quarter is generally a seasonal low and especially in the activity-based fee-generating businesses in terms of lending and capital markets. But in general, the diversity in our businesses continues to support very good momentum in our fee generation. Fees and commissions for the year is at ISK 12.5 billion, which covers 62% of our operating expenses, which is considerably up from 35%, for example, in 2019. And the first 9 months of 2023 remain a record fee-generating period for this business from a historical perspective.Assets under management pleasingly increased between years despite very challenging markets and now stands at ISK 1,300 billion or just below the balance sheet of the Bank. And we actually saw a net positive inflow of assets under management during the quarter.In terms of our insurance results, I think we generally view this as being a pleasing result with -- and the progress we are making in the insurance business is in the right direction. This, of course, continues to be a long-term key strategic project for the group. In terms of the top line, premiums were just under 19% up from the third quarter of last year, and we continue to see the bancassurance model supporting this business.For an example, on the corporate side, we see strong growth that has been achieved at low cost by utilizing the distribution network of the CIB business. The combined ratio for the quarter was just over 88% with a cost ratio of 16% and a claims ratio of 72.6%.So looking at operating expenses. It is worth noting here that we -- on this page, we present the operating -- total operating expenses for the group, which include the operating expenses related to the insurance business, which are included in net insurance results in the income statement. Total operating expenses for the quarter was ISK 6 billion, and increased by 4% from the third quarter last year compared to 8% inflation during this period. Total operating expenses, as discussed in previous earnings calls, we had some one-off items in Q1. And for the past couple of quarters, we have a better representation of the run rate cost base of this group. It is also, however, worth noting that Q3 is generally a low in terms of operating expenses from a seasonal perspective.So now moving on to the balance sheet and starting with the loan book. The loan book grew by just under 1% to around ISK 9 billion during the quarter. Growth has been slowing over the past few quarters, both on the retail and corporate side. And in the quarter, we actually saw no growth on the corporate loan book. The main driver here is, of course, simply the general slowing of the economy and activity among our clients. It should, however, also be noted there is also a managed impact as a response to increased capital thresholds from S&P as outlined in previous earnings calls.Out of the total growth in the quarter, around ISK 4 billion is a result of inflation impact on our CPI-linked lending, while there is also a reduction of ISK 2.5 billion related to FX impact. The total loan book continues to be very well balanced, 47% in mortgages, 5% to other loans to individuals and 47% to corporates.So moving on to loss allowance. The total loss allowance at the end of the quarter is 0.75% of the loan book, and net impairments for the quarter was -- were just under ISK 750 million. In general, the theme is the same as what I described in Q2, where we have seen a slight uptick in nonperforming loans over the year, which is to be expected in the current rate environment. However, the size is still low from any historical perspective.As discussed during the year, we have prudently reflected the evolving economic outlook in our IFRS assumptions throughout the year. 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.Deposit growth continued during the quarter with an increase of 3% from the end of the second quarter and 9% from the third quarter of last year. Total deposits now stand at ISK 806 billion or just under 60% of the total liabilities. Our loans-to-deposit ratio has, therefore, reduced slightly and now stands at 142%. As we have discussed, our strategy in this area is to be competitive, especially in the more stable categories of deposits from clients which have multiproduct relationship with the Bank and in terms of term deposits. As we have highlighted on the top right chart of this page, all of the growth over the past year and deposits has been in these categories.Moving on to wholesale funding. A key highlight in this area, of course, was the upgrade from Moody's to A3 during the quarter. This was a strong confirmation of the evolution of the group, and it was good to see Moody's reference the Bank's sustained performance, the shift towards bancassurance business model, while maintaining a strong asset quality as well as getting a raise for the score in governance. The upgrade should support the wholesale funding efforts of the group, and it has been positive to see the secondary spreads in our Eurobond tightening in recent months. At the same time, of course, this means that there is now effectively a [ 2.5 note ] differentiator between our A3 Moody's rating and the rating from S&P, which is an unusual position.In terms of our funding profile, we have managed this conservatively over the past year and with a view, of course, of the general volatility in the capital markets. We issued a [ EUR 300 ] million senior in the second quarter which prefunded our Q2 maturity next year. This means that we have a very strong MREL position with a buffer of over 12%. And this allows, of course, for very good headroom in terms of our issuance plans where our next euro maturity is in Q4 2024. We also have a current bond maturity in ISK in Q2 next year, which will be refinanced through monthly issuance in the domestic market.Last week, we then announced a call of the outstanding SEK 500 million Tier 2 bond. As the total capital position of the group is very strong, this will not be replaced. We will continue to manage our funding position conservatively and aim to be active in the ISK market regularly over the coming year as well as exploring opportunities in the -- in other markets.So looking at capital. Again, our position is very strong with a common equity ratio of 19.4%, which increased by 50 basis points during the quarter. The leverage ratio continues to be very strong at 11.8%. This means that our buffer above regulatory common equity requirements is now 450 basis points. This position, of course, as usual, includes a foreseen dividend payment corresponding to 50% dividend payout ratio. Obviously, this is well above our medium-term management buffer targets, which we have set at 150 to 250 basis points.Based on these targets, we, of course, have a capital surplus of around ISK 15 billion to ISK 25 billion. However, as outlined in our Q2 call, our capital planning near term is, of course, impacted by the S&P change in economic risk assessment, as outlined in the Q2 call. Again, this effectively -- this move from S&P effectively increased the Tier 1 capital threshold for our business by 2.5%, and it corresponds to a Tier 1 buffer above regulatory targets of around 500 basis points. This, of course, is a key driver for our capital management near term. But as Benedikt mentioned, over the medium term, we do anticipate that regulatory and rating agency capital benchmark should convert to a greater extent, again, as the Icelandic economy proves its resilience and/or through other rating factors.So before I hand over to Q&A, I want to again highlight some of the key themes going forward. So we concluded another solid quarter, strong first 9 months of the year, where we are effectively meeting all our medium-term targets. The sharp increase in policy rates have started to have the expected impact of slowing the Icelandic economy, which has in turn slowed the growth of our balance sheet.It was a positive signal of the progress when it comes to managing inflation that the Central Bank kept the rates unchanged in the last meeting. Our diverse businesses and strong and mature market position in all key business unit means that we continue to be in a very good position to navigate the current market conditions. This is further supported by very conservative management of capital, funding and loan provisioning as well as very ongoing cost discipline.The rating upgrade from Moody's in the quarter was a positive confirmation of this position and the group's operational momentum in recent years. It was also pleasing to see the Icelandic sovereign being placed on positive outlook from S&P and Moody's earlier this year, a strong signal of the resilience of the Icelandic economy.As discussed, our capital position continues to be very strong, as was further strengthened during the quarter. That 450 basis point common equity Tier 1 buffer is again well above our medium-term targets. But as discussed, capital management near term is impacted by the S&P considerations.And finally, as Benedikt mentioned earlier, we very much look forward to presenting our updated key strategic initiatives as well as revised review of key operational targets when we host our last Capital Markets Day on the 1st of March next year. This will be hosted in our offices here in Reykjavik and we hope, of course, to see many of you there.So thank you again, and I'll now hand over to Theodor Fridbertsson for Q&A.
Thank you, and good morning, everybody. As usual, we start with Q&A from the online participants and then move on to the auditorium.We have 2 questions, one on the insurance and one on the market side from Tellimer. So I will start. The insurance income has been weak in several recent quarters and claims grew significantly in Q3. Is the premium growth target encouraging you to take on riskier business? And what does the shift towards more corporate business mean for the long-term profitability of this division?
Yes. If I start and, Olafur, you fill in. Historically, the competition in the Icelandic insurance market has been such that when interest rates are high and performance of investment portfolio associated with that is decent, the market has been pricing its premiums with kind of higher combined ratio assumption and making most of its return on the investment portfolio. It's however, good to see that from the results that have already been published that Vordur is actually posting a combined ratio which is favorable, lower or comparable to the competition and is still well below 100%. And whereas the -- obviously, the investment results are yet to be shown due to mark-to-market impacts from prices falling both in equity and bond markets. Olafur, you want to add something?
No. I think answering the first question, we're not taking on more risk. I think the key -- one of the key goals with the bancassurance project is to increase the diversity within the Vordur business. Vordur has been very focused on auto insurance, on the retail side and life insurance. We are now broadening the pillars of that business by growing, especially, on the corporate side, in the SME space, especially. And we're able to do that at a low cost, a lower cost than our competition has been able to do. And this is the key driver. So I think we're creating a more robust business for the future. And like you said, I think that we are pleased with both the top line and the actually profitability now on the insurance side, of course, not on the market side, but the combined ratio actually is trending in the right direction and it is comparable to the competition lines and strong.
Yes. So we're diversifying the risk within the portfolio.
And then secondly, on the mortgages for the forthcoming nominal fixed maturities, what type of products do you expect customers to switch into? And how will this impact your margins? And secondly, is this transition expected to create any asset quality pressure?
Well, the recent trend has been that people are moving from variable non-CPI-linked mortgage product to either variable CPI-linked or a fixed CPI-linked. It's common to have a blended kind of mortgage, 50-50 or some version of that. And we expect this trend to continue. We don't see this impairing the asset quality since the LTV -- kind of average LTV on the portfolio is, from an historical standpoint, quite low and has been lowering in recent years. And the fact of the matter is that this market is in general -- the average duration for the lender has shortened quite substantially. There's a lot of refinancing activity taking place. The cost of refinancing is low. And so the challenge for us, obviously, is to manage the imbalances that this could create on our -- to our NIM and our CPI imbalance.And as Olafur mentioned, this is probably going to result in a little bit more fluctuation in the net interest income line every quarter now, and it's a function of 2 things: the CPI in the quarter; and obviously then real policy rates where they stand at on average reported.
Yes. And I'll have [indiscernible] to add. I think, of course, as we've said before, in terms of the margin impact, of course, I think we've said before, this is a tailwind in -- over the coming year. Of course, these are -- the fixed rates are on average non-CPI-linked around 5%. And they're, of course, resetting into a higher-margin product if they remain with the Bank. So that is a short-term payment for NIM.
I think you answered the longer term view.
Yes.
And we do not have any other questions from the online participants. So are there any questions from the auditorium? No?Then I guess, we can conclude this webcast. And thank you all for participating and also to the online participants. And we'll see you in Q4. Thank you.