Arion banki hf

ICEX:ARION

Q2-2025 Earnings Call

[Ida Benediktsdottir, executive]

Good morning, everyone, and welcome to Arion's Bank presentation on the second quarter results. My name is Ida Benediktsdottir. I'm the Deputy CEO and MD of the Retail Bank. The agenda for the call today is that I will start by going over the highlights of the quarter, and I give a short update on the Icelandic economy and also a short update on the proposed merger -- quicker merger discussion. And then Benedikt Gislason, the CEO, will go into the numbers in more detail and give the outlook going forward.

But before I start the presentation, I would like to remind our participants online that they can submit questions during the presentation through the message board located below the feet. And we will provide answer to your questions at the end of the webcast. First of all, we are very happy with the strong results of the year and the positive first half. The return on equity attributable to Arion's shareholders was 19.7%, bringing the return on equity for the first half to 16.1%, which is well above our medium-term targets of 13%. We saw a good momentum in core earnings, mostly higher net interest income as well as a very strong quarter in terms of fee and commission income, led by our CIB and Markets business unit.

We have also reached a milestone in development assets, mainly Arnarland that support a valuation increase of ISK 500 million in the quarter for our 51% ownership in that development project. We saw moderate insurance premium growth and a good increase in our bancassurance ratios during the first half of the year. Vordur had a very strong quarter with combined ratio of 79.4%, well below the 95% medium-term targets. Capital optimization is on track and moving closer to optimized levels. CRR3 implementation later this year is expected to have further increase of surplus capital of around ISK 9 billion. We did further capital distribution through dividends and buyback during that period in the first half of the year of around ISK 22 billion. Kvika merger is expected to further increase the capital level from this current stand-alone position. And finally, we enjoy strong capital and liquidity position, which is very comfortable in the current operating environment.

So if you look at the quarter, key operational highlights, you can see that we have had a very active quarter. For the ninth consecutive year, the Arion app was rated the best banking app in Iceland by customers. We have also received awards from Euromoney as the best bank in Iceland, second year in a row now. As we have announced previously, we launched our Arion Rewards platform earlier this year, which has proven to be very well received by our customers. A few items to mention on the funding and capital side. In the quarter, we issued ISK 10 billion of Tier 2 bonds in Icelandic kronas supporting our capital optimization. We issued green bonds in Swedish and Norwegian kroner amounting to ISK 20 billion equivalent. And we also concluded a share buyback program of ISK 3 billion in June.

We saw excellent results relating both to our CIB and market business with a record fee quarter in CIB, supported by strong activity both in the lending and advisory side. Key milestones was also reached in the market business unit with the finalization of Arngrimsson Advisor acquisition, supporting our third-party assets under supervision business. And it's also nice to say that we have renewed our long-term agreement with Frjalsi Pension fund and experienced a very strong momentum in our Premia business. Our insurance business continues to expand with ongoing growth in our bancassurance ratio for both individuals and corporates. And finally, we announced a very exciting development where Arion Bank and Kvika signed a letter of intent entering merger discussions. So I think we should look at that in more detail.

So in the recent year, we have followed a very deliberate and well-defined strategy. We have focused on capital-efficient revenue growth whilst delivering the surplus capital to our shareholders. We have focused on our core operation and simplified our balance sheet. And we are focused on building a long-term client relationship and offering a diverse and proven product portfolio. The group performance over the past years, which continued now in the first half of this year indicates that we are on the right track with this strategy. The proposed merger with Kvika is a natural progression in the strategy and has a strong potential to further enhance the operational performance of the group and the service that we offer to our clients.

There are 3 arguments from a business perspective that I would like to mention here in this webcast that form a strong rationale for the combination of these 2 companies. Firstly, there is a clear strategic alignment between the strategies of the 2 banks. Kvika's operation fits very well with our long-term focus on the Arctic region and also a new product development in the asset management space. The fintech services -- Kvika fintech services also complement our digital strategy and fintech investments. And we also serve an overlapping customer segments and share similar values, which further strengthen this case for demerger.

Secondly, we see a significant synergy potential, both on the cost and the revenue side. Kvika's brands will enhance the value proposition and expand our product offering, supporting our core strategy. At the same time, their brands will benefit from a larger balance sheet and a broader customer reach. I will go a bit more into the detail of the timeline in the next slide. But following the due diligence process, we will share more information on the synergy estimates and the overall investment case.

And thirdly, we believe that the merger will strengthen our capital and liquidity position with even further capital relief anticipated due to CRR3, which is -- will hopefully be implemented later this year. But beyond these business fundamentals, we believe that the merger will create value for all stakeholders. And if I start with customers, customers across the combined group will gain from a stronger product and service offering, supported by substantial synergies that will lead to lower prices. Employees of both companies will gain new opportunities as a larger organization opens up roles and responsibilities, both in Iceland and internationally. And the broader society will gain from the overall value creation of the merger and the larger combined entity could support the community with increased lending capacity. And finally, a point from the investor perspective. Based on our base case assumption, the merger is expected to be accretive from 1 year forward.

So in terms of the timeline, we believe that the merger can be completed under year, ideally before 9 or 12 months. But of course, this is highly dependent on the regulatory approval process. We have split, as you can see here on the slide, the project into 4 phases. And currently, we are in Phase 2, which includes the due diligence work and early discussions with the competition authority, which we hope can start next month. We will continue to update the market on the key developments of the merger.

And now just a few words on the Icelandic economy. I start with the GDP. The GDP dipped in 2024, but it's already turning up. Latest forecast show a slower, steadier recovery and the sharp rebound that we previously expected, as you can see here on the top left chart. Domestic demand, especially consumer spending is driving the recovery. In the bottom left chart, you can see that inflation has been stuck around 4%, still well above target. And it is likely that it will remain there for quite some period of time, at least for the rest of this year. And therefore, we believe that there is a little room for further rates cut this year.

An interesting fact also household gross disposable income is raising ahead of consumption, creating an intentional saving buffer, as you can see here in the top right chart. That surplus cash can power continued spending even if the labor market softens. On the negative side, trade war tariffs and possible drop in U.S. tourist demand are the main headwinds, but they are likely to trim, not to a growth. A stronger krona helped with a weaker dollar amid with the U.S. trade debters has dampened import prices, but not as much as one should expect and not enough to break the inflation plateau. It may also affect tourist spending, adding to our export sector uncertainty.

And to sum up, a steady consumption-driven rebound is on the horizon, but inflation is still a speed bump and a monetary policy will remain tight until we see the data convincingly turn. The krona is to devalue from a strong level, imported inflation could add another speed bump to the inflation outlook and extend the tight monetary policy of the Central Bank. Now I would like to welcome Benedikt Gislason, the CEO of the bank, to go over the numbers in more detail.

[Benedikt Gislason, executive]

Thank you, Ida. Starting with some key takeaways for this quarter. A very strong second quarter with an ROE to shareholders of 19.7%. The results in our core earnings are the primary reason for the strong earnings. It was a very good quarter in net interest margin. The net interest margin with rather high inflation and lower funding costs, somewhat explained by timing of market funding, as I'll explain in a later slide. It was also a very strong quarter in terms of fee generation, especially in CIB and the diversification was also greater than in the first quarter, as I will explain later on. Insurance service results were very strong with lower costs in claims and moderate growth in insurance income.

We also continue to see progress with the land development projects that we've been working on, which supported the valuation increase in the quarter. And finally, our capital position is trending near the target of the bank following a ISK 3 billion buyback program concluded in the second quarter, as previously mentioned. Liquidity position remains robust following successful funding activities in the first half of the year. And we are now starting to shift our focus to maturities next year relating to both covered bonds and senior preferred issuance.

Now we take a look at the income statement. Core income, which we define as net interest income, fee and insurance revenues were ISK 20.7 billion, which is up from ISK 17.3 billion in the second quarter of last year or 20%. Net interest income was up by almost 19% and fees were up by more than 14%. Insurance service results are strong in the quarter and increased by 104% from the same quarter last year. This is mainly due to lower claims. Financial income was impacted by challenging equity markets, resulting in ISK 179 million income, including the investment portfolio of the insurance business and our market making operations, but still improvements from the same period of last year. But there are on the financial income line, we're still tracking below what we had budgeted for.

Other operating income is ISK 1.3 billion, which mainly relates to the valuation uplift of our development asset, Arnarland, which is currently in a sales process. The net results is, however, impacted by the minority interest holding in that asset, which reduces the net impact to around ISK 500 million, as Ida explained. Operating expenses decreased by 6.4% between years, but it's worth noting that the second quarter last year included one-off expense of ISK 580 million. And excluding that, the increase of OpEx was around 2%. Net impairments in the quarter was positive, mainly due to the number of loans performing better than previously accounted for. The effective tax rate was 28% in the quarter, which is slightly higher than expected due to negative impact from losses on equity holdings, which are not deductible.

So the net profit for the quarter is therefore ISK 9.8 billion compared to ISK 5.5 billion for the second quarter of last year. And now we should look at some of the line items in more detail. And starting with the net interest income. Net interest income in the quarter was ISK 14.2 billion, up from ISK 12.2 billion in the first quarter and from ISK 11.9 billion in the second quarter of last year. The net interest margin as a percentage of interest-bearing assets is 3.5%, unusually high and is higher than our guidance of 3% over the year. The key drivers of the higher NIM in the quarter are the CPI imbalance was ISK 196 billion at the end of June and rose by ISK 32 billion since the last quarter and by ISK 52 billion compared to the end of second quarter of last year, partially due to the final repayment of a covered bond class, CBI 25 in April. So a relatively high inflation quarter has considerable effect on the net interest income.

The cost of funding has decreased alongside falling Central Bank policy rates dropping from 9.25% at the end of second quarter of last year to 7.5% at the end of this quarter. Additionally, the cost of borrowing has decreased both funding and FX and final payment of the CBI 25 bond class that I mentioned in April. I would also like to mention that we redeemed a Tier 2 subordinated bond in February. That bond was denominated in ISK, both CPI-linked and non-CPI link. And we only reissued another Tier 2 at the end of May. So we saved a little bit of interest expense on our Tier 2 financing over a few months.

Going to the net fee and commission income, another very strong quarter in terms of fee generation with total fees of just over ISK 4.5 billion in this last quarter. Most of our fee-generating businesses are doing well, and it is good to see that the core fee generation is rather stable through the cycle. Demand for new lending was very strong in the corporate space during the quarter with loans to corporates increasing by ISK 33 billion or 5.5%. And the turnover or the volume of lending, obviously, is much higher as the maturity of the loan portfolio needs to be refinanced. I would also like to mention that in the first quarter, which was also a good quarter for fee generation, close to 10% of the fee generation in that quarter was related to a single advisory assignment, whereas in the second quarter, the diversification of the fee generation is substantially greater.

Now coming to Vordur, our insurance business. The insurance business of Vordur has continued to develop in a positive way over the last few quarters. There are obviously fluctuations in the operations between quarters, but generally, the development has been favorable. Insurance income increased by about 5%, while claim expenses decreased by 17% in the first 6 months compared to last year. So for the first half of the year, the combined ratio was 89.4%, which is the lowest ratio for that period for Vordur and probably the lowest in the market.

Operating expense including those from the insurance business, which is consolidated in our accounts. Total operating expenses in the quarter were ISK 7.6 billion, which is down by 1.5% from the second quarter of last year. It's worth mentioning that in the second quarter of 2024, there was a one-off impact of ISK 580 million. But excluding that, the increase in total OpEx was around 2% between years. The number of FTEs has been relatively stable between quarters, but from the same quarter last year, the increase in FTEs have been around 6%, mainly related to IT and growing insurance operations. So taking that into account, I would argue that costs are under good control in this quarter.

Moving into our balance sheet and starting with the loan book, which grew by 3% or ISK 38 billion to ISK 1,272 billion. This growth is primarily related to the increased demand for new lending in the corporate side, as I mentioned. As discussed in previous calls, we remain dynamic in the way we manage the loan growth with a view on balancing credit strategy and profitable growth opportunities. And recently, we have been seeing more interesting opportunities on the corporate side and the turnover in the loan book has also been significant, as I mentioned earlier. But the loan book continues to be very well balanced with 45% in mortgages, 6% other loans to individuals and 49% to corporates.

Now looking at our risk profile. As discussed, we had a positive outcome from our impairment calculation for the quarter. This is mainly due to a number of loans performing better than previously accounted for. However, nonperforming loan ratio has increased since year-end 2022. The nonperforming loans ratio is associated with changes in the policy rate and its future trajectory may be influenced by the speed of monetary easing. Currently, the ratio, however, remains below historical averages. Total loss allowance at the end of the quarter is ISK 9.3 billion or 76 basis points of the loan book, which is at the same level as in recent quarters.

Coming to deposits. Deposits continued to grow in the quarter, increasing by 1.6% or just under ISK 15 billion to almost ISK 900 billion. As we've stated before, our strategy in this area has been to compete, especially in more stable categories of deposits. As we have highlighted in the top right chart of this page, all the growth this year has been in these categories, sort of the stable deposits. Regarding the interest margin, it's important to note that we've passed on most of the policy rate reductions across various deposit categories in recent months. As previously discussed, we anticipate that the high deposit beta observed during the rate hiking cycle will be similar on the way down, which limits the sensitivity of net interest margin.

As previously mentioned, our funding profile remains robust and the bank maintains a conservative approach regarding the refinancing of market funding, payment of senior [ EUR 300 million ] bond in third quarter of this year has been prefunded and work regarding funding of [ ISK 500 million ] covered bond in third quarter of next year and senior [ EUR 300 million ] has already started. During the second quarter of 2025, the bank issued the senior preferred bonds in Norwegian kroner and Swedish krona for a total amount of around ISK 20 billion. And as I mentioned earlier, issued a new Tier 2 subordinated bond at the end of May for proceeds of ISK 10 billion. Arion Bank's long-term issuer rating for Moody's were affirmed at A3 and at Aa1 as a covered bond issuer with stable outlook.

And my final slide before summarizing and opening -- an estimate slide before opening to Q&A is our capital adequacy and capital position, which continues to be strong with a CET1 ratio of 18% or 259 basis points above regulatory requirements and still above our 150 to 250 basis point target, including the management buffer. I think it's worth mentioning that our capital requirements have increased by 60 basis points since last year, 50 basis points of that comes from the increase in the countercyclical buffer and 10 basis points comes through the Pillar 2 requirements. And the subcategory within the Pillar 2 requirements that contributes to this 10 basis points is the interest rate and indexation risk. As outlined in previous presentations, we then expect some net positive impact from the CRR3 implementation, as Ida mentioned, which we now expect to be implemented before the year-end of 2025. The initial impact on capital relief is anticipated to be approximately ISK 9 billion.

Now before turning over to Q&A, I want to again highlight some of the key themes going forward. A very strong first half of the year with core business providing good earnings and the diversity of our business provides support for the overall earnings momentum through the cycle. We continue to cautiously anticipate a continuing complicated external operating environment near term, both in terms of domestic rate development and in terms of the international political landscape. And thirdly, the proposed merger with Kvika is a natural step in our strategic journey, as Ida explained in her presentation, which will provide numerous opportunities to further strengthen the business and services to our clients. In this presentation, we're not providing any information on synergy estimates or value accretion for our shareholders, but we intend to do so as we progress with the second phase of our work, which includes DD and prediscussions with the ICA.

With that, I want to conclude the presentation and suggest that we move into a Q&A session. I welcome Eggert Teitsson, Deputy CFO, to the stage with me and Ida. And I welcome also our Head of Corporate Communications, Haraldur Guoni Eidsson, to the stage to lead the questions.

[Haraldur Eidsson, executive]

Good morning, everyone. As usual, we will start with questions from our online participants. We have a few questions from Alexandra [indiscernible]. First one is actually on the synergies. But as Fred mentioned, we will not be giving an update on that for now. So we'll start with a question on the NIM. Where do you see the NIM for the year as a whole, given the current outlook?

[Benedikt Gislason, executive]

Yes. Our guidance has been for the NIM to be within the 2.9% to 3.2% range. And based on our first half figures, I think it's fair to assume that we will probably be operating in the upper end of that range for the year, but we still remain or sort of continue to guide for this range as this kind of the -- obviously, the volatility between quarters has increased with the CPI imbalance and changes in the real policy between corporate -- real policy rates. So it's pretty hard to give any kind of precise predictions for each quarter, but we feel comfortable still guiding for these rates.

[Haraldur Eidsson, executive]

Another question from Alexander. Can you give an update on a potential timeline for any transaction or milestones for Blikastaoir?

[Benedikt Gislason, executive]

Yes. So obviously, we're very pleased with the progress that we've made with Arnarland, and I think that demonstrates that we have the ability to develop interesting residential areas in the capital area in close cooperation with the local municipalities. Currently, the zoning plan for the first phase of Blikastaoir is undergoing, and we are working closely with the municipality of [indiscernible] on this. This is around 1/3 of the overall project, which is being planned, 1,200 units.

And I think it's worth mentioning that we've taken -- in terms of valuation, we've taken an approach of valuing this asset in line with development of CPI. So there is a slight markup in this quarter of ISK 160 million as we feel that land at least tracks development of CPI over the long term. But once we make new milestones, which would then be sort of the zone planning for -- zoning planning for the first phase, we would, as we've done with Arnarland, make more sort of valuation adjustments.

[Haraldur Eidsson, executive]

Okay. And the final question from [indiscernible]. Can you comment on the realized loss on investment property in Note 11? Is that related to Helkuvik or something else?

[Benedikt Gislason, executive]

Yes, we can confirm that -- so we sold off that asset at the end of second quarter, and we took sort of marked the asset down in the first quarter and then we crystallized the losses by the sale, the overall kind of P&L impact in the first half is, yes, it's around ISK 400 million. But yes, so -- but this is no longer our asset, and we don't carry the cost -- operating cost that comes with it.

[Haraldur Eidsson, executive]

So there are not more questions from our online participants. Are there any questions from people in the audience? Well, they have not. We thank you for joining us this morning and wish you all the best for the rest of the summer. Thank you.

[Benedikt Gislason, executive]

Thank you.

[Ida Benediktsdottir, executive]

Thank you.