Financials and funding 2020

Finances and funding   

Íslandsbanki’s operations were successful in 2020, even though they were unconventional because of external conditions. We made good progress on the expenses side, and our deposit and loan portfolios expanded. Net interest income increased year-on-year, as the growth of the loan portfolio offset the impact of lower interest rates. Uncertainty relating to COVID-19 could be seen in negative impairments and an increase in forbearance, but even so, there has not been an increase in non-performing loans.  

Income statement

Total operating income increased in the quarter

• Net interest income remained stable in the fourth quarter but increased by 1.7% between years, as the balance sheet growth was somewhat offset by a lower interest rate environment, resulting in a slight fall of 0.1% in the net interest margin. A higher deposit margin compensated for a drop in lending margin both during the quarter and for the year as a whole.
• Net fee and commission income remained stable during the quarter. A slight drop between years was mainly due to reduced payment card and currency exchange activity in the wake of COVID-19. Fees from loans and guarantees increased considerably between years.
• In 4Q20 the Bank recorded a gain of ISK 783m in financial income. However, the Bank recorded a loss of ISK 1,391m for the full year 2020, compared to a loss of ISK 820m in 2019. This is attributable to losses in the trading book and the banking book, CPI hedges and fair value changes in shares.

Cost / income ratio below the Bank’s target of 55%

• Administrative expenses dropped by 5.8% during the quarter and 7.1% for the year. The fall is mainly explained by lower salaries and related expenses and an overall reduction in the Bank’s cost base, partly due to COVID-19.
• The number of FTEs at the end of the period excluding seasonal employees was 745 (749 at YE19) for the parent company and 779 for the Group (783 at YE19, not including FTEs from a subsidiary previously held for sale for comparability).
• The cost-to-income (C/I) ratio for the Group was 51.7% in 4Q20 compared to 62.9% in 4Q19, therefore on target, which is a C/I ratio below 55%. For 2020 the C/I ratio was 54.3% compared to 58.8% in 2019. The C/I ratio excludes the bank tax and other one-off items.

Lower bank tax contributes to lower expenses

• Income tax for the period amounted to ISK 2.5bn, compared to ISK 3.9bn in 2019.The effective tax rate for the period was 26.5%, compared to 30.7% in 2019. The bank tax accounted for ISK 1.6bn compared to ISK 3.5bn in 2019. The Bank is subject to the special financial tax of 6% on taxable profits in excess of ISK 1bn. The Bank pays financial activities tax and social security charges, makes contributions to the Depositors’ and Investors’ Guarantee Fund, the Financial Supervisory Authority of the Central Bank, and the Office of the Debtors’ Ombudsman. The contribution to the Depositors’ and Investors’ Guarantee Fund, was ISK 679m, an ISK 257m reduction from the previous year. Total taxes and levies amounted to ISK 6.6bn for the period compared to ISK 10.3bn in 2019.

Impairment charges continue and uncertainty in operating environment still in place

• The ISK 1,829m impairment charge in 4Q20 is mostly COVID-19 related and due to update to macroeconomic scenarios and other assumptions.
• Loan impairment charges and net valuation changes generated a loss of ISK 8,816m in 2020, compared to a loss of ISK 3,480m in 2019. Thereof, ISK 6.1bn is COVID-19 related, ISK 1.2bn is related to a handful of customers and ISK 0.6bn linked to an update in macroeconomic scenarios and weights.
• The net impairment charge over loans to customers was 0.18% in 4Q20 (0.73% annualised) and 0.91% in FY20.
• The economic scenarios used to calculate the impairment were updated in 4Q20, although it must be noted that determining the appropriate scenarios in the current environment is challenging. The main assumptions in the base scenario are that GDP will be -8.6% in 2020 and 3.1% in 2021. Additionally, the weights of the scenarios have been adjusted to reflect the outlook, the weights are now at 15%-55%-30% (good, base, bad) compared to 25%-50%-25% before the pandemic.

Underlying operations deliver stable operating income

• Íslandsbanki reported a profit of ISK 3.5bn in 4Q20 (4Q19: ISK 1.7bn), generating a 7.6% annualised return on equity after tax (4Q19: 3.7%).
• Profit after tax was ISK 6.8bn in 2020 (2019: ISK 8.5bn) and annualised return on equity after tax was 3.7% in 2020 (2019: 4.8%). The ISK 1.7bn lower profit between years is mainly explained by an increase in loan impairment charges and net financial loss. Contributing to higher profit in 2019 is a one-off item included in other operating income in 2019.

Balance sheet

Solid growth in loans to customers

• The growth of the Bank’s asset side by 12.1% is mainly attributable to loans to customers and bonds and debt instruments and depreciation of the Icelandic króna. The loan growth is a result of strong demand for residential mortgages (increase of ISK 60.3bn in 4Q20 and ISK 95.7bn from YE19). The rise in demand for mortgages was largely driven by the lower interest rate environment. Outstanding loans to the tourism industry in Iceland at year-end were 9% of the loan portfolio.

• Loans are generally well covered by stable collateral, the majority of which is in residential and commercial real estate while the second most important collateral type is fishing vessels. The weighted average loan-to-value (LTV) ratio for the residential mortgage portfolio was 64% at the end of 2020 compared to 62% at YE19. Following a sharp rise in recent years, the Central Bank’s CRE price index has fallen in 2020. Íslandsbanki’s registered value of commercial real estate as collateral has risen at a much slower rate and lagged market prices in prior years. The Bank’s CRE loan portfolio is therefore less vulnerable to market price changes.
• Three items, cash and balances with the Central Bank, loans to credit institutions and bonds and debt instruments, amounted to about ISK 297bn, of which ISK 285bn are liquid assets. After the Central Bank decided to stop offering one-month term deposits the Bank shifted ISK liquidity to Treasury bills, short dated Treasury bonds and covered bonds to earn higher yield.

General moratoria taper off

• Íslandsbanki entered into an agreement with other lenders in Iceland to provide a moratorium for corporate and household customers, uniformly executed across institutions. At its peak, around 1,500 households and 650 companies benefitted from measure with loans amounting to around ISK 200bn.
• The agreement expired on 30 September 2020 and the maximum length of the moratoria was through 2020. Further extensions of moratoria may be granted on a case-by-case basis, but such extensions will be classified as forbearance.
• At year-end, 11.1% of the gross performing loan book (not in stage 3) was thus classified as forbearance, up from only 2.9% at end of Q3.
• Support loans with government guarantees amounting to ISK 3.7bn were originated in 2H2020. Around 60% of the amount is with full government guarantee. These loans are part of the support measures that the Government has put in place following COVID-19 and Íslandsbanki facilitates the process.

Quality of loan portfolio high but uncertainty of COVID-19 pandemic impact prevails

• At the end of the reporting period, the share of credit-impaired loans to customers was 2.9% (gross) for the Group (2019: 3.0%). In January 2021 one material exposure was fully repaid as expected, bringing the ratio down to 2.7%. The collateral coverage in Stage 3 was 70% at the end of the year 2020 and the reserve coverage ratio was 25.3%.

Growth in customer deposits YoY

• Deposits from customers fell by 2.7% in the quarter but grew 9.9% from YE19. The ratio of customer loans to customer deposits rose to 148.2% at the end of the year. Deposits from retail and corporations are the Bank’s main source of funding, comprising 42% of the Bank’s total funding sources and 78% of the Bank’s total deposit base at year end. Stable deposits are increasing from YE19, up 12% from retail customers and corporations and up 7% from financial institutions and pension funds. All deposit concentration levels are monitored closely, with concentration falling slightly during the year.
• Other liabilities decreased between years due to less volume of unsettled transactions at the end of the period.
• Debt issued and borrowed funds increased during the year as the Bank continued to build on its main long-term funding sources by issuing covered bonds and senior unsecured bonds.
• The Bank held seven covered bond auctions during 2020, issuing a total of ISK 26bn by tapping three outstanding bonds as well as issuing a new bond ISLA CB 27. Issuance in the fourth quarter amounted to ISK 18bn, net of maturities. The issuance of covered bonds is to fund the Bank’s mortgage portfolio and furthermore to diversify and optimise the Bank’s funding base.
• In November, the Bank issued its first bonds in a sustainable format and the first sustainable bond by an Icelandic bank. Having just signed its Sustainable Financing Framework, the Bank approached investors with a 3-year, EUR 300 million benchmark bond through lead managers ABN Amro, Barclays, Goldman Sachs and UBS. Demand for the transaction proved to be very strong with the order book nearly reaching a 4x oversubscription. The resulting issue was priced at mid-swaps +100 basis points and placed with investors across Europe. This transaction was swiftly followed by a green bond, this time an ISK 2.7bn 5-year senior issue in the local market which was the first green bond issued by an Icelandic bank. The proceeds will be allocated to green, blue (sustainable fisheries) and red (social projects) over the course of the year ahead.
• Due to successful capital market transactions and growing deposit base the Bank´s liquidity ratios strengthened during the year. The Group’s total liquidity coverage ratio (LCR) was 196% (194% for the parent) increasing from 155% at YE19. After the sale of the subsidiary Borgun hf. in July 2020 the difference between Parent and Group LCR is negligible. The LCR in foreign currencies increased to 463% at end of 2020 from 325% at YE19 and LCR in ISK was 95% at year-end compared to 110% at YE19.
• The Central Bank’s reduction of the reserve requirement in 1Q20 resulted in increased liquidity. No unexpected increase was in the use of overdrafts and revolvers during the period.
• The total net stable funding ratio (NSFR) was 123% at period end compared with 119% at YE19 and the NSFR in foreign currencies was 179% compared with 156% at YE19.
• As the Bank’s liquidity position remains strong across currencies and above requirements, the Bank may consider debt buybacks or exchanges of outstanding transactions during 2021.

Capital ratios strengthened during the year and are well above regulatory requirements

• Total equity amounted to ISK 186bn at the end of 2020, compared to ISK 180bn at YE19. Thereof, ISK 1.5bn is attributable to non-controlling interests.
• The Financial Supervision Committee announced in September 2020 that the results of the 2019 SREP assessment concerning additional capital requirements (Pillar 2-R) shall remain unchanged at 17% of REA.
• In March 2020 the Central Bank of Iceland lowered the countercyclical capital buffer from 2.0% to 0% due to the economic uncertainty caused by the COVID-19 pandemic. This lowered the Bank’s overall capital requirement from 19.0% to 17.0%. The Bank’s capital ratio target, which is currently the Bank’s regulatory total capital requirement in addition to the Bank’s management buffer of 0.5-2.0%, lowered in line with the removal of the countercyclical capital buffer to 17.5-19.0%.
• Due to the uncertainty in relation to the effects of COVID-19 on the capital base, the Bank aims to have an ample buffer above the current target until there is further clarity regarding international travel and other sources of uncertainty.
• At the end of the year, the Bank’s total capital ratio was 23.0% compared to 22.4% at YE19. That is considerably higher than the Bank’s total capital ratio target. The Bank’s Tier 1 ratio was 20.1% at the end of December compared to 19.9% at YE19. Implementation of IFRS 9 transitional rules in Iceland, where IFRS 9 impairment is partially included as CET1, increase the CET1 capital by ISK 5.0bn. The depreciation of the ISK increased the value of the Tier 2 subordinated bonds, increasing the capital base even further.

• Íslandsbanki uses the standardised method to calculate its risk exposure amount (REA), which amounted to ISK 934bn at the end of December 2020 compared to ISK 885bn at year-end 2019. REA amounts to 69% of total assets at year-end 2020 compared to 74% 2019. The large increase in mortgage lending lowered the ratio of REA total assets along with the SME supporting factor that was implemented in Iceland on 1 January 2020, resulting in an ISK 14bn deduction in the risk exposure amount at the end of December 2020. REA in total increased due to growth in loans to customers.
• The leverage ratio was 13.6% at the end of year compared to 14.2% at YE19, indicating low leverage.
• The Board of Directors proposes that ISK 3.4 billion will be paid in dividends to shareholders, which is 50% of profits in 2020 and is in line with the Bank's policy of paying dividends of 40-50% of the profit of the year. The Board may convene a special shareholders' meeting later in the year to propose payment of additional dividends if the Bank's accumulated capital reserves are considered to exceed its long-term capital requirements.

Strictly monitored imbalances

• The Bank is exposed to inflation risk because CPI-linked assets exceed CPI-linked liabilities. At the end of December 2020, the Bank’s consolidated net inflation (CPI) imbalance amounted to ISK 26.2bn, compared to ISK 20.7bn at YE19. The imbalances are managed amongst other things via CPI-linked swaps, issuance of CPI-linked covered bonds and CPI-linked deposit programmes.
• The currency imbalance was ISK 5.1bn (2.4% of the total capital base) at the end of 2020, compared to ISK -93m (0.05% of the total capital base) at year-end 2019. The Bank's imbalances are strictly monitored and are within regulatory limits.

Credit rating

• Íslandsbanki is rated by S&P Global Ratings (S&P). In late April 2020 S&P lowered Íslandsbanki’s rating to BBB/A-2 with a stable outlook from previous BBB+/A-2 with a negative outlook.
• S&P’s rationale for the change is mostly derived from its view that economic activity will reduce in Iceland and Europe in 2020 and thus could impair Íslandsbanki’s asset quality, increase credit losses, reduce business and revenue generation, and potentially erode its capital. S&P’s view is that Iceland's operating environment will remain challenging, affected by the 2020 economic recession, declining interest rates, stiff competition from pension funds in mortgage lending and thus contributing to the declining profitability of Icelandic banks.
• In its report, S&P expects Íslandsbanki to enter this crisis on a more solid foothold than the 2008 financial crisis. The 'BBB' rating level and stable outlook factor in the solid market position of the Bank in Iceland, which has a relatively advanced digitalised banking platform. In S&P’s view, the Bank is well ahead of many other European banks in its preparation for technological disruption. S&P also notes the Bank’s funding and liquidity metrics are adequate for the Bank’s risk profile, with comfortable liquidity ratios and liquid assets covering more than 3x the average short-term funding in 2019. Moreover, S&P states that the wholesale funding needs are limited in 2020, which coupled with the additional central bank liquidity facilities announced recently by the Icelandic Central Bank, eases pressure on liquidity needs.