Good morning, and welcome all to the presentation of the second quarter results 2026 for Arion Bank. My name is Ólafur Höskuldsson, and I am the CFO of Arion Bank. Today's agenda is as follows. I will start by working through the key financial highlights for the quarter. My colleague, Deputy CEO and Head of Retail Banking, Iða Brá Benediktsdóttir, will cover the key operational highlights and outlook going forward. Before I start the presentation, I would like to remind participants online that you can submit questions throughout the presentation through a message board located below the video feed. We will then provide answers to the Q&A after the presentation. Starting as usual with the key highlights for the quarter and the first half of the year.
First, another solid quarter with an annualized ROE of 15.5%, which then takes the return on equity for the first half of the year to 14.6%. The clear milestone for the group is that this quarter, with these results, we are for the first time exceeding all our financial medium-term targets. Again, these results are broad-based and with most key business units delivering a solid profitability and supporting diversified and robust results through the cycle. In terms of growth, the positive is that we continue to find solid loan growth opportunities both in corporates and mortgages. This growth, again, continues to be supported by very strong growth in stable deposits.
We do, however, continue to see increasing signs of the economy being impacted by the prolonged period of high interest rates in Iceland. This is likely to become a headwind for growth should this remain the case, should rates remain elevated going forward. Finally, and of course, always very importantly, our balance sheet continues to be very strong. We maintain a very robust capital and liquidity position, as well as having proactively and conservatively increased provisioning early in this cycle. With most of the upcoming bond maturities pre-financed early, we have a very strong and light maturity profile.
Now looking more closely at the income statement. Net profit for the quarter was ISK 8.1 billion, compared to ISK 7.3 billion in the first quarter. Core income, namely net interest fees and insurance income, was ISK 21 billion, which is around 1% increase from this quarter last year. Financial income was again negatively impacted by the equity markets in Iceland, which impacts, of course, the investment portfolio of Vörður, the insurance business, and our market-making business. We also had a close to ISK 300 million loss from a conservative revaluation of our unlisted equity holdings in this quarter. Because of these losses, again, in equity holdings, the effective tax rate is again somewhat high in this quarter at 28%. Cost of risk is 19 basis points with an impairment of just under ISK 700 million.
Now looking at some of the key line items. Starting with net interest income. Net interest income in the quarter was ISK 15.2 billion compared to ISK 14.2 billion for this quarter last year. The annualized net interest margin as a percentage of interest-bearing assets was a solid 3.5%, which is similar to the margin for this quarter last year, but somewhat down from, of course, an unusually high margin for the first quarter. I have, of course, covered this in some detail in previous calls, but again, we do expect some continued fluctuations in the margin near term as our inflation-linked loan portfolio is impacted by monthly real policy rates and monthly inflation prints.
Again, of course, these products are not priced based on three months real interest rates, and we tend to look through these short-term movements when managing these products and are very confident in the resilience of the margin going forward. We continue to guide investors for a margin over the medium term of over 3%. Looking at fees and commissions, a decent quarter in terms of fee generations with total fees of just under ISK 4 billion. In general, our fee-generating businesses are doing well and demonstrating strong stability through the cycle. As discussed, this prolonged period of elevated interest policy rates are, of course, a headwind for some of our transaction-related fee-generating businesses, namely in the CIB and Markets areas. It's good to see that despite this, we are seeing very strong stability in fee generation for the business.
Of course, clearly, when there is upside in this area, when we do see policy rates coming down, we are in a very strong position in these areas on the transaction-related fee side going forward, which will increase economic and market activity, of course, when policy rates come down. Moving on to the insurance business. Growth momentum continued, with insurance revenues growing by just under 7% for the first half of the year, and growth continuing to be exceeding the market growth, which is of course, one of our key financial medium-term targets. The combined ratio for the quarter was a solid 87.9%, while somewhat higher than what was unusually strong this quarter last year. This takes the combined ratio for the first half of the year to 94.3%.
While we are pleased with the good growth momentum and profitability of the insurance business, the overall earnings from Vörður, of course, continue to be impacted by the challenging market conditions on the investment side. We continue to anticipate that this business will become a very strong contributor to the overall earnings of the group and profitability when we see normalized earnings on the investment side. So now we're looking at the total operating expenses, including those from the insurance business.
Total operating expenses in the quarter were ISK 8.4 billion, which is up by around ISK 860 million between years but r oughly half of this relates to salaries, and out of that half related to salaries, around ISK 200 million relates to a change in accounting for our incentives scheme between years, which I effectively see as a one-off impact. Excluding these items, salaries increased by around ISK 240 million or around 5% between years. For comparison, the number of employees increased by just under 4% between years. At the start of the year, we had a 3.5% general wage increase related to the union collective wage agreement coming into effect.
In terms of other expenses, these were similar to what we saw in the first quarter, but they do increase by ISK 440 million between years, and this mainly relates to IT expenses and investments. Moving on to the balance sheet and starting with the loan book, which grew up by around ISK 66 billion in the quarter to ISK 1,418 billion. Growth in the retail book was just under 2%, while on the corporate side, we continue to see good growth opportunities. The corporate loan group grew up by just under 8% in the quarter.
While we continue to be generally opportunistic in the way we grow the loan book, we do anticipate that growth will slow in the second half of the year, in the coming quarters, as both the pipeline on the corporate sides was rather sort of seasonally top-heavy for the year, and we of course also see some slowdown in the economy which we expect to impact loan growth going forward. The loan book continues to be very well balanced with 42% mortgages, 5% other loans to individuals, and 53% to corporates. Looking at our provisioning position, as discussed, we have a ISK 679 million impairment in the quarter or 19 basis points. This takes the total loss allowance at the end of the quarter to ISK 12.4 billion or 0.9% of the loan book.
The increase in provisioning in this quarter was mainly related to an increase in Stage 1 provisions, where we have conservatively worsened some of our macroeconomic assumptions in our modeling. The general story is, however, similar to what I've described in recent quarters. Non-performing loan ratio was relatively stable this quarter, but it has been increasing over recent quarters, which is to be expected in the current rate environment. Credit quality indicators remain, however, very robust. As discussed, we retain a very conservative provisioning position, and we increased provisions early in the cycle, which we are benefiting from currently.
The sector perhaps that we are monitoring most closely these days in the current environment is obviously the construction sector, which is probably seeing the biggest impact of the current rate environment and the slowdown in the housing market. As discussed, I think we test this portfolio, which is around ISK 120 billion, regularly against very punitive stress tests and macro outlook scenarios and are very confident in our provisioning, which is appropriate and conservative. Deposits continued to grow in the quarter, increasing by ISK 44 billion to ISK 981 billion. As I always say, our strategy in this area has been to compete, especially in the more stable categories of deposits. As highlighted in the top right chart of this page, the growth has continued to be in those categories.
As we have discussed previously, the deposit beta in Iceland, so the relationship between deposit cost and policy rates, is very high compared to other countries. This is a headwind for the interest margin currently for the Icelandic banks. I think it's important to note that when policy rates come down, this also means that there's a lot of room for deposit costs to come down along with it, which will protect the margin in that scenario. Finally, looking at capital, our position continues to be very strong. Common equity ratio at 17.7%, 242 basis points above regulatory requirements.
Of course, as discussed, following a very focused effort over the past years to manage our capital towards our optimized capital level, it is a strong milestone for the group to have now reached this level within the target range. The leverage ratio continues to be very strong at 11%, of course, well above most European peers. In terms of MREL, we also have a very robust position with substantial buffers above requirements. On that point, I would now like to welcome our Deputy CEO and Head of Retail Banking, Iða Brá Benediktsdóttir, to go through some of the key operational highlights and the outlook going forward.
Thank you, Ólafur, and good morning, everyone. As Ólafur mentioned, solid first half of the year. All medium-term targets are achieved for the first time. Return on equity was 15.5% in the second quarter and 14.6% for the first half of the year, ahead of our medium-term targets of exceeding 13%. The results are driven by strong development in core earnings and continuing cost discipline across business. Core operating income over REA was 7.9% in the second quarter, ahead of our 7.2% target. While the cost to core income ratio was just over 40%, well below our 45% target, thus demonstrating a sustained cost discipline even as the business continues to grow. The combined ratio for Vörður was within our 95% target for the first half or 94.3%. As Ólafur mentioned, this was particularly strong in the second quarter.
We see further growth opportunities for Vörður through our Bankasýn strategy, leveraging on Arion's customer base, both in the app as well as with physical presence within our branches to deepen the relationship and increase cross selling. We continue to make strong progress in our capital optimization, with CET1 ratio standing at 242 basis points above regulatory requirements, although within our management buffer. This supported a capital distribution of ISK 23 billion in the first half of the year through dividend and buybacks and at the same time supported a healthy loan growth. Going forward, we will continue to manage profitable balance sheet growth alongside with capital distribution through buybacks and dividends.
Now, looking at the few of the key operating highlights in the quarter, Arion Bank was recognized as having the best banking app in Iceland for the 10th consecutive year, reinforcing our strong customer proposition and digital leadership. On the funding side, we successfully issued EUR 300 million of preferred senior debt in May. The issuance was eight times oversubscribed with a very diverse investor participation. Maturities for 2026 are now fully funded, and the funding profile remains well-diversified with limited near-term refinancing need. We launched the sale process of Blikastaðaland earlier this month, on one of the largest development areas in the capital region.
The objective of the sale is to attract experienced and well-capitalized investors with knowledge in this field who can lead this development going forward. Across the group, AI adoption progressed in line with our plans. AI implementation is an important strategic priority for the group. During the quarter, we broadened adoption of enterprise AI tools and continued to strengthen our technology foundations needed to capture efficiency gains, improve customer service, and support long-term innovation and a t the same time, we delivered a record number of IT projects during the quarter.
In Asset Management, Stefnir further strengthened its product offering and growth potential with the launch of Katla Government Bonds Icelandic UCITS Fund. The launch of this fund represents another step in Stefnir's international strategy to attract international capital into the Icelandic financial market by offering a local currency Icelandic sovereign fixed income through Luxembourg fund structure. As Ólafur mentioned before, activity in the Corporate & Investment Banking remained strong, supported by continuing strong loan growth and solid advisory projects including Laxey, Controlant, Nicetravel, and Garri. This shows the diversity of the opportunities across the business that we have and are operating and a strong foothold of our Corporate & Investment Banking.
The earning impacts of those activities are not fully reflected in this current quarter. Finally, insurance operations delivered accelerating premium growth and a growing customer base, and we are enjoying high customer satisfaction. Building deeper and longer-lasting customer relationships remains a key strategic priority for the group. I would like to provide you some additional color on what we are doing in this area. During the quarter, we continued to strengthen our ecosystem and our loyalty proposition through Arion Rewards. The program has now more than 60,000 customers, and the rewards deposit account has achieved strong deposit growth since it launched late last year. We also expanded our physical presence by opening a new full-service branch in Keflavík, enhancing accessibility and supporting customers in Iceland, one of the fastest-growing regions.
It is worth noting that Vörður had a very strong foothold in this region, and we are leveraging on that by opening this joint branch. Our digital proposition remains a key differentiator. As mentioned earlier, once again, Arion was recognized as having the best banking app in Iceland. During the quarter, we further enhanced the customer experience through personalized digital services using activity feed in the app to deeper integration and offer personalized loyalty offerings through our app. We launched Arion Future, which we are very proud of. It is an initiative designed to build loyalty among the younger generations b y combining financial education, relevant products, and tailored benefit across the group and t here we are building on the infrastructure of our loyalty program and the success of Women Invest.
This is a group initiative where we, for example, offer new insurance product and a mutual fund tailored directly to this group and which are only sold in the Arion app. We are also seeing strong results from our premium customer proposition. Arion Premia continues to attract affluent clients through specialized service. Overall, bancassurance momentum remains strong. Penetration has increased steadily and is now 43.5% in our retail business. In Premia, we are having 48% bancassurance ratio. Finally, NPS and overall customer satisfaction among both retail and corporate customers are at all-time high. Before we go into Q&A, I want to highlight some of the key themes going forward.
A solid first half of the year where, again, the diversity of our business provides support for the overall earnings momentum through the cycle. Furthermore, we see that the customer engagement is increasing across all segments, supported by improvements in our services and also the success of our loyalty program. We will continue to be flexible and opportunistic, both in pricing and balance sheet management and n ow, as Ólafur mentioned, for the first time, we have reached our optimal capital ratios. With capital ratios within optimal range, future loan growth will be supported by organic capital generation. We continue to cautiously anticipate the continuing complicated external environment near term, both in terms of domestic high inflation and rates development and also in terms of the international geopolitical landscape.
Regarding the referendum at the end of August of reopening EU accession negotiations, it is still too early to tell the effect or the impact of the economy if yes will be the answer of this referendum. Clearly, this is a first referendum in what will likely be a multi-year process. With regards to impact on our business, there are several uncertainties which we are always evaluating and planning for. As always, the main focus for us is to run an efficient bank and serve our clients well and to maintain a flexible strategy allowing for us to react to any changes quickly in the external environment.
Unfortunately, inflation continues to remain persistent with latest figures of 5.3%, thus contributing to a higher for longer policy rate outlook. Importantly, our balance sheet remains very strong. Capital funding and liquidity ratios are all solid, and we are taking proactively conservative approach to provisioning. We are not making any change to our strategy targets or capital priorities for the time being, so consistency is the message here. We will continue targeted IT investment, particularly in AI and cybersecurity, and our AI implementation strategy is becoming clearer with measurable opportunities now taking shape.
We remain selective on value accretive opportunities, ones that benefits our clients, shareholders, and the broader economy. With that, we will now turn into the Q&A. For those joining online, you can submit your questions through the webcast platform. I would now like to welcome our Head of Investor Relations, Theódór Friðbertsson on the stage who will moderate the discussion. Welcome, Theódór.
Thank you, Iða. Good morning, everyone. I think as usual, we start with the questions from the online participants, then we'll move into the auditorium. Starting with questions from Alexander from AKKUR, number one, four questions from him. OpEx grew 10.9% year-on-year in Q2, cost-to-core is 40.4% against your 36%-40% range. How much of the 9% salary growth in the wage review clause versus headcount? What is the IT run rate from here? When specifically does the growth rate decelerate back inside the range?
Yeah, I'll take that one. Thank you for a good question. I think I probably answered it partially in the presentation. The salary increase year-on-year, around 50% of that 9% increase is related to sort of one, what I would say is one-off, is related to the change in accounting of the incentive scheme. If you take that out, there's roughly a 4.5% increase in salary then between years, which is around 50/50 sort of split between headcount and wages. Of course, in that period, we've had around 5% inflation. I think that's a reasonable result. He asked about when we return to the 36%-40% range, which I think is we have a target cost-to-core income ratio in our mid-term targets of 45%.
We are well within the mid-term target. We want to be always lower, and I think we've been exceeding this target now for a while, so of course, t hese targets are evaluated annually. We will be looking at those targets along with others again at the end of the year. In terms of IT costs, I think it is an area which has been the key driver of increased costs for the banking system and probably most companies for the recent past years we are investing in recquired infrastructure to be able to service our clients but I think we always try to manage that as best we can.
I think interestingly, as probably Iða talked about the AI investment, which everyone is now, of course, focused on and is a very interesting area for the future. I think in the short-term, for most companies and ourselves included, it's a net cost. We're investing currently in what we see as something that will drive efficiencies in the future. For the short term, it's going to be increasing costs, and we have to invest with the plan. How we time the outcome of those investments is something that we probably will be presenting at a later date, I think. I hope that covers the full question.
Yeah. Thanks. Next one is on our development asset, Blikastaðaland, which we launched the sales process recently. The question is, what is the expected disposal timing and rough magnitude through other income? Maybe Iða.
Yeah. The sales process was announced earlier this month. We have a deadline in September, but of course, the main focus for us is to find strong investors with capabilities to finalize this project. The book value of Blikastaðaland is now ISK 7.2 billion. I think it is too early for us to tell what the impact will be. The objective has not been simply to sell it as quickly as possible and t herefore, we have been working a lot to make it more attractive, marketable, and also de-risk the project for those that are going to buy it. I think it is just too early to tell, both on the timing and also on the expected sales price.
Mm-hmm. The net financial income was negative by ISK 68 million on unlisted equity revaluations. The question is which positions, is the write-downs complete? Ólafur.
Are they complete? It's difficult to say. I think, as I've said, we try to mark these. It's around ISK 3.8 billion portfolio now that we have of unlisted equities, we always just try to value these stakes very conservatively. The bottom of any range of transactions or valuations that we see in the market. That doesn't say anything about the future, of course. Unfortunately, we did another valuation markdown of our position in Akta, which is the largest unlisted holding that we have, which is around ISK 1.5 billion currently. As I said last time, it's a very interesting company with a bright future, but we want to be just very conservative in the way, again, we value it so t hat's why we took it down again by ISK 300 million this quarter j ust under ISK 300 million.
If I may add, on Blikastaðaland, of course, we will do what is best for our shareholders in this case as well.
Yeah. Then the final question from AKKUR is that fees fell 13.5% in the first half despite strong corporate lending volumes. Why is lending related fee generation decoupling from volume, and is the first half run rate the right base?
Yeah. I probably covered some of this also in the presentation. I think if you look at last year, we had a very large transaction closing at the beginning of the year. The Marel JBT, one of the biggest M&A transactions in Iceland historically, which we were involved in. It's difficult to compare to that period. I think, like I said, the composition of the loan growth is just different than it was last year. There are less transaction-related loans, so it's more traditional lending business, which has a lower fee generation associated with it. I think despite that, we are generating relatively good fees out of this business. Again, with huge upside, when transactions in the market recover again, and we see more transactions, we are in a very good position for that increasing again.
Mm-hmm. We have two more questions here coming in. Iða, you have spoken, as Ólafur touched upon this earlier, and you spoke about the AI development and improving the customer experience for different customer segments. How do you see the AI impact on costs today?
It is difficult to tell exactly the impact of the cost today but I can tell you, for example, in our core IT teams, we are seeing increased productivity of around 25%-30%. People around the bank are starting to use this also quite frequently to augment their work, but we have been working a lot on this. We have the AI corporate governance in place. We have the risk framework in place. We are working on the delivery models, so h opefully we can tell you in more detail perhaps later this year or in the Capital Markets Day how it will affect the cost. For the time being, we are augmenting and helping our employees to get used to it, to learn how to use it and make their work easier, stop to do more manual work and focus more on projects that are more valuable, so to say.
Here is the last question, probably to both of you. With the solid loan growth in the quarter, mainly in the corporate loan book, and capital levels now within your CET1 buffer range, how should we think about the balance between growth and future capital distribution?
Good question. I think we, of course, as a bank, have been very active in the buyback space. Probably setting some sort of Icelandic record. We, I think, bought back around 1/4 of our outstanding shares in the past two years. Buybacks are always a key part of how we optimize shareholder returns. It's always something that we consider. Of course, this business has now been generating sort of 13%-15% returns for a number of years now, very steadily. I think, of course then, when you're in that position, growing that sort of business is also driving shareholder returns.
I think we're in the business of lending. We're a bank, of course our core business is serving our client so it's very good if we can find growth opportunities as those returns. It's something that we just look at opportunistically at every time, whether we find opportunities. If we don't, we return it to shareholders, and we've shown consistently that we've done that.
Iða, anything to add there?
No, I think just to second that.
Yeah.
Yeah. That concludes the questions from the online participants. Any questions from the auditorium? Yeah, Helgi.
Hi. Helgi from Landsbankinn. My question is on the ROE. Obviously, the first time you deliver over 14.5 %. At least that small cap index is guiding the second half down considerably compared to the first half. How do you see your ROE developing in the second half of the year?
Maybe just to repeat the question. How are we seeing the ROE developing for the second half of the year?
It's difficult to give a very precise answer. I think if you look at, of course, our net interest margin, if you look to break down the components of our income statement, net interest is now impacted, of course, by inflation. I think most analysts are seeing inflation peaks coming down for the second half of the year. It should have impact, we have been having consistently surprises on the upside on the inflation side recently.
Yeah.
Of course, if inflation comes down as well, we hopefully have rates expectations also coming down, which should help the markets and our financial income, fee business. It's difficult for me to give anything. We have a 13% ROE target. We are confident in exceeding that-
Yes.
...over the medium term.
Now we have an optimized capital position, which is also a key component, of course, to deliver those returns. I think, I don't know if you want to add anything to that.
No, that's fine.
Maybe just one more. On the loan book, the loans in foreign currency are increasing some ISK 30 billion. Is that an area where you're focused on keep growing, or how do you see that sort of play out?
We have, of course, said that we are looking at the Arctic, and the loan growth there has been preliminary in that field, but also in some projects that we know very well, such as something related to fisheries and aquaculture. We have favorable terms now when we go to the market abroad, for example, with this EUR 300 million preferred issue that we did. So that is a part of our strategy to be growing as well in the Arctic region.
Just echoing on the point on the funding cost.
Yeah.
I think for Iceland and the Icelandic bank support is a key positive, and I think the result of a lot of effort over the past years to broaden the investor base and get our funding costs in FX down. We've seen it's a very positive position that we are in now, I think. If you look at where these investors are coming from, it's become much broader and diversified than we saw a few years ago w hich is very strong for the future for the system. We're using that, like Iða said, because our funding cost is now down, we can bid for transactions that we weren't able to do before.
But-
That's allowing us to grow.
Yeah, what's the business that we know quite well.
Yes.
Thanks. Appreciate it.
Any final questions? No? I think that concludes it for today. Thank you very much for attending and we wish you a good rest of the summer.