Cost to income ratio trends downward

• Administrative expenses grew by ISK 457m in 2019 or 1.7% year-on-year. The rise is due to salary cost related to employment termination during 2019 amounting to ISK 805m and higher depreciations due to investment in the core banking system.
• The number of FTEs at the close of the period excluding seasonal employees was 749 (834 in 2018) in the parent company and 984 (1,075 in 2018) for the Group. Due to employee redundancies in 2019 it is expected that salary costs will fall in 2020. In the last five years FTEs within the parent company have decreased by 169.
• The cost-to-income (C/I) ratio for the Group in 2019 was 62.4%, compared to 66.3% in 2018. The C/I ratio excludes the bank tax and other one-off cost items. The C/I for the parent company was 57.1% for the same period compared to 60.4% in 2018.
• The after-tax loss from discontinued operations was ISK 125m in 2019, compared with ISK 912m gain in 2018. The loss was generated by lowered value of foreclosed assets.

Negative net impairment on financial assets reflects changes in economic outlook

• Loan impairment charges and net valuation changes generated a loss of ISK 3,663m in 2019, compared to ISK 1,584m gain in 2018. The 2019 change is due to impairments for specific customers, a less favourable economic environment and an unfavourable ruling in a court case. The loan impairment charges are in line with estimated cost of risk.

Taxes and levies continue to affect profitability

• The tax on the profit for the period amounted to ISK 3.7bn, compared to ISK 4.7bn in 2018. The effective tax rate was 30.1%, compared to 32.7% in 2018. The bank tax accounted for ISK 3.5bn in 2019, compared with ISK 3.3bn in 2018. The Bank is subject to the special financial tax of 6% on taxable profits in excess of ISK 1bn and makes contributions to the Depositors’ and Investors’ Guarantee Fund, the Financial Supervisory Authority, and the Office of the Debtors’ Ombudsman. The contribution to the Depositors’ and Investors’ Guarantee Fund, was ISK 936m, an ISK 237m decrease from the previous year. Total taxes and levies amounted to ISK 10.3bn in 2019 compared to ISK 11.4bn in 2018.
• With changes to law no.155/2010 in December 2019, the bank tax will decrease linearly from current 0.376% to 0.145% in 2023. Despite this decrease the Icelandic banking sector is affected by much higher tax burden, both in comparison to other sectors in Iceland as well as other European banks.

Profitability marked by negative net impairments

• Profit after tax was ISK 8.5bn in 2019 (2018: ISK 10.6bn) and annualised return on equity (after tax) was 4.8% in 2019 (2018: 6.1%). Earnings from regular operations were ISK 10.5bn, (2018: ISK 12.0bn) and annualised return on equity from regular operations normalised for 16% CET1 was 6.6% in 2019, compared to 8.0% in 2018. Regular earnings fell by ISK 1.5bn between years, mainly explained by an increase in loan impairment charges and net valuation changes.
• Return on equity is below the Bank’s long-term target. The target is based on risk free rate plus 4–6%. Based on the average risk-free rate in 2019, the target would be 7.7 - 9.7%. In order to improve returns, the Bank took several actions to optimise its operations under the framework of a new policy.

Assets – growing balance sheet through continued growth of loans to customers

• The balance sheet grew by 6.1% from year-end 2018, to ISK 1,199bn with loans to customers growing by 6.3%, or ISK 53.0bn. Demand for new credit came from all the Bank’s business segments but was concentrated mostly in Corporate & Investment Banking. Mortgage loans rose by ISK 32.2bn from year-end 2018. New lending amounted to ISK 226bn in 2019, as opposed to ISK 239bn in the previous year, a decrease of 5.7%. Outstanding loans to the tourism industry in Iceland decreased proportionately and are now 10% of the loan portfolio which is well diversified.

• Loan growth was strong in 1H2019 or 5.7% but in 2H2019 growth was 0.6%. Total growth during 2019 was 6.3% and exceeded economic growth of 0.3%. Lending in ISK was the main growth contributor. In 2019 a greater proportion of lending was financed via deposits than previously.
• The ratio of customer loans to customer deposits fell to 145.5% at year-end 2019, compared to 146.2% at end 2018.
• Loans are generally well covered by stable collateral, the majority of which was 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 62% at end of December 2019 and was 61% at year-end 2018. The increase in LTV of mortgages is partly due to that additional loans available to first-time buyers are now included in the definition of mortgages.
• The Bank’s asset encumbrance ratio was 18.1% at end of December 2019 compared to 18% at year-end 2018.
• Three items – cash and balances with the Central Bank, bonds and debt instruments, and loans to credit institutions – amounted to about ISK 254bn, were ISK 223bn of which are liquid assets.

Quality of loan portfolio still measures highly by international comparison

At the end of the reporting period, the ratio of impaired loans and advances was 2.4% for the Bank compared to a 2.9% weighted average for European banks at the end of September 2019 (2018: 3.4%). When only considering the quality of loans to customers, the NPL ratio in terms of the gross book value was at 3.0% at end of December (2018: 2.0%).

• Liabilities – successful funding through deposits and capital markets issuance
• Total liabilities amounted to ISK 1,019bn, an increase of 6.8% from year-end 2018. The Bank maintained strong liquidity levels throughout 2019, and all regulatory and internal metrics were well above set limits at the end of the period.
• At year-end 2019, the Bank’s liquidity coverage ratio (LCR) for all currencies was 155% for the Group (144% for parent), 325% in foreign currencies and 110% in Icelandic króna. The net stable funding ratio (NSFR) for the Group in all currencies was 119% and the NSFR in foreign currencies for the Group was 156%.
• Deposits from customers increased by 6.8% from year-end 2018, to ISK 618bn. Deposits are still the Bank’s main source of funding and concentration levels are monitored closely.
• The Bank´s market-based funding activities continued to be successful during the year with issuance of covered bonds, CPs and senior unsecured transaction in Icelandic krona and senior unsecured transactions and subordinated debt in foreign currencies. These transactions will further diversify the Bank´s funding base. Covered bond issuance amounted to total of ISK 29bn in 2019 or with net issuance of ISK 10bn.
• In April, the Bank issued a EUR 300m 3-year benchmark fixed rate bond at a spread of 130 basis points over 3-year mid swaps. The transaction was issued concurrently with a tender to buy back EUR 300m of the Bank’s outstanding EUR 500m 2020 benchmark bond.
• In June, Íslandsbanki issued a SEK 500m (10NC5) Tier 2 bond. This was the Bank‘s third Tier 2 bond issue and with this transaction the Bank reached its Tier 2 target which is an important milestone in optimising its long-term capital composition.
• Íslandsbanki issued a senior unsecured ISK bond amounting to ISK 3.6bn in November. The bond was priced at 1m REIBOR+90bp. This is the Bank´s first ISK senior transaction and is an important milestone in the build-up of the domestic bond market. The bonds were sold to a wide range of domestic investors.
• In December Íslandsbanki bought back in full a SEK 250 million Note due 27 February 2020 and EUR 142.7m out of EUR 200m Note due in September 2020. The buyback decreased the Bank‘s refinancing risk.
• According to Íslandsbanki’s issuance plan for 2020 the Bank estimates to have a limited need to raise funds in FX in 2020. However, the Bank will contemplate issuing Additional Tier 1 capital instruments in foreign and/or local currencies.

Equity

• Total equity amounted to ISK 180bn as of year-end 2019, compared to ISK 176.3bn at the end of 2018. Thereof, ISK 2.4bn is attributable to non-controlling interests. At the Bank‘s AGM in March shareholders approved the Board‘s proposal to pay dividends amounting to ISK 5.3bn.
• At the end of December, the Bank’s total capital ratio was 22.4%, (2018: 22.2%). That is slightly higher than the Bank‘s total capital ratio target which is currently the Bank´s regulatory capital requirement in addition to the Bank´s management buffer. The Bank’s Tier 1 ratio was 19.8% at year-end 2019, compared to 20.3% at year-end 2018. In October 2019, the Central Bank lowered the minimum requirement for total capital for Íslandsbanki from 19.3% to 18.8%. The decrease is credited to the Bank’s lower risk profile.

• Considering recent changes to regulatory requirements and an updated assessment of the business environment, the Bank revised its management buffer from 0.5-1.5% to 0.5-2.0%. It is worth noting that the Central Bank increased the countercyclical capital buffer from 1.25% to 1.75%, in May 2019 and a further increase by 0.25% came into effect in February 2020. Íslandsbanki‘s target capital ratio is currently at 19.5-21.0%, taking into account rise in counter cyclical capital buffer from February.
• Íslandsbanki uses the standardised method to calculate its risk exposure amount (REA), which amounted to ISK 884.5bn at year-end 2019, or 73.7% of total assets. The leverage ratio was 14.2% at year-end 2019 compared to 14.6% at year-end 2018, indicating low leverage.
• The Board of Directors of Íslandsbanki proposes that ISK 4.2 billion will be paid in dividends to shareholders for the 2018 financial year. The dividend corresponds to about 50% of after-tax profits for 2018 and is consistent with the Bank’s dividend pay-out ratio target of 40-50%. The Board may convene a special shareholder meeting later in the year where a proposal regarding payment of dividends of profit for the previous financial years could be suggested.

Ratings

• Íslandsbanki is rated by S&P Global Ratings (S&P). In July S&P affirmed Íslandsbanki‘s BBB+/A-2 rating but changed the outlook to negative.
• In its report, S&P refers to Íslandsbanki’s stable domestic market position and acknowledges the Bank’s success in introducing new digital products and improving its IT infrastructure, placing Íslandsbanki well ahead of many other European banks. S&P also notes the Bank’s exceptional capitalisation, strong liquidity levels and robust asset quality.
• S&P’s rational for the change to negative outlook is mostly derived from its view that Iceland's operating environment will remain challenging, affected by the 2019 economic recession, declining interest rates, still-high taxation, and stiff competition from pension funds in mortgage lending, and thus contributing to the declining profitability of the Bank.
• In January 2019, the Bank announced it would terminate its credit rating agreement with Fitch Ratings, a decision which was driven primarily from a cost perspective. In November 2018, Fitch had affirmed the Bank’s rating of BBB/F3, with a stable outlook.