Good morning, and welcome to Arion Bank's presentation for the third quarter results 2026. My name is Ólafur Höskuldsson. I am the CFO of Arion Bank. Today's agenda is as follows. I will start by walking you through the key financial highlights from the quarter. Then our Chief Economist, Erna Björg Sverrisdóttir, will provide an update on the Icelandic economy before our CEO closes with an overview of the key operational highlights and the 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 questions in the Q&A sessions at the end of the webcast. Starting as usual with the key highlights.
First, another solid quarter with an annualized ROE of 16.3%, which takes the return on equity for the first nine months to 15.1%. I want to take the opportunity this time to highlight the relative stability in our earnings over the recent years. For example, over the past three years, we have had over 85% of quarterly earnings exceeding our medium-term target of 13%. Of course, the full-year results have exceeded those 13% since 2020. Again, the profitability is broad-based, and our key business areas are all supporting each other and contributing well through the cycle. As we have seen in recent quarters, the rate environment in Iceland has continued to pose challenges in domestic capital markets, and thus our Markets and Stefnir business have been impacted.
These businesses are, however, very strongly positioned for the turn in the cycle when they can again contribute and counter potentially more challenging environments in other areas. This, of course, is the key benefit of having a broad-based and diversified business. In terms of growth, we have continued to see strong growth in stable deposits, which has been a key theme over the past two years. During this quarter, we reached the benchmark of deposits exceeding ISK 1,000 billion. Finally, the balance sheet continues to be very strong. We maintain a robust capital and liquidity position and have conservatively increased loan provisioning early in the cycle. With most upcoming bond maturities pre-funded early, our funding profile is also very robust. We are then refreshing our capital target this quarter, which has been broadly unchanged since our IPO in 2018.
We now target a common equity management buffer of between 100 basis points-250 basis points, and we guide to a near-term guidance in terms of capital that we target a buffer around the midpoint of that range. This means that we have around ISK 15 billion of capacity to optimize further our current position of 320 basis points above regulatory minimum. As before, we will continue to do that through a combination of balance sheet growth, dividends, and buybacks over the coming quarters. Now looking more closely at the income statement. Net profit in the quarter was ISK 8.7 billion compared to ISK 8.2 billion for this quarter last year. Core income, namely net interest, fees, and insurance revenues, were ISK 21 billion, increasing by around 11% from this quarter last year.
Financial income was again negatively impacted by the equity markets in Iceland, which again impacts our investment portfolio, especially on the insurance side and the market-making operations. Operating expenses were then increased by ISK 800 million between years. It should be noted that in this quarter, we had a combination of just under ISK 500 million related to one-off items, including redundancies and the settlement with the Icelandic regulator. Cost of risk was then 27 basis points with impairments of just under ISK 1 billion. Finally, we have not accounted for the potential increase in the Icelandic Bank Levy, which is proposed by the government in the recent budget. This is still subject to parliamentary vote, and should this be confirmed as expected, the full impact for this year is then expected in the fourth quarter, and we anticipate this to be around ISK 1.7 billion.
Just for reference, should this impact have been included on a pro-rata basis in the current period, the third quarter ROE would have reduced to 15.5%, and the nine-month ROE to 14.3%. Looking more closely at some of the key line items, starting with net interest income. Net interest income in the quarter was ISK 15.8 billion, up from ISK 15.2 billion in the second quarter. The annualized net interest margin as a percentage of interest-bearing assets was a solid 3.5%, which is similar to the margin for the recent quarter, but again, somewhat higher than what we guide as through the cycle average of above 3%. I have, of course, covered this in previous calls, but again, we do expect some continued near-term fluctuations in the margin related to the inflation-linked loan portfolio as monthly inflation prints and real policy rates do fluctuate.
We do, for example, anticipate lower inflation measure in the fourth quarter based on analyst projections, and this will have an impact if that materializes on the fourth quarter NIM. As discussed in previous calls, these CPI-linked loans are, of course, priced not for a few months, but a longer duration. As such, we are very confident in the profitability of these products through the cycle. It is worth noting that a large portion of these loans are also floating rate, which means that we have the ability to adjust the interest rates should there be a real shift in policy rate, real interest rate levels in the market, which then impacts our cost of funding for these products.
Looking at fees and commissions, I think it is fair to say that in general, there has been pressure on our fee businesses recently, which I think it is fair and expected in the current environment of slowing growth, elevated deposit rates, and subdued capital markets activity. We do, however, continue to deliver what I would say as defensively strong fee generation at just under ISK 4 billion per quarter, and these continue to be relatively diverse and broad-based. As we have discussed, we are in a very good position to leverage on a turn in the market backdrop with a leading position, for example, in asset management and investment banking, where we continue to invest and strengthen. Looking at the insurance business, Vörður. The story is similar to what we have described in recent quarters. Good trajectory on the insurance side, but again, subdued investment income.
The growth momentum continues to be very solid, with insurance revenues growing by 6% in the nine months and with growth continuing to exceed the market growth. The combined ratio in the quarter was a solid 85.7%, which then took the combined ratio for the first nine months to 91.4%. Looking at the total operating expenses, including those from the insurance business. Total operating expenses in the quarter were ISK 7.9 billion or around ISK 500 million, again, below recent quarters. Q3, of course, is, as most of you know, generally a seasonal low in terms of salaries due to annual leave taken in the quarter. The headline increase in total expenses is high between years, as I mentioned earlier, or around ISK 900 million, but there are, as discussed, key two one-off items in the quarter to note.
First, as announced yesterday, we signed a settlement fine with the regulator for a cost of just under ISK 300 million. As you know, of course, these are not tax deductible. Second, we had a round of redundancies in the quarter, and the one-off cost associated with those is around ISK 200 million. We remain very focused on ongoing cost discipline and are currently working on a number of initiatives, including related to AI, which can strongly support the efficiency of the business going forward. This will be further outlined in our Capital Markets Day in March. Moving on to the balance sheet and starting with the loan book, which was broadly flat between quarters and stand at ISK 1,415 billion. Following a few quarters with relatively robust growth, especially on the corporate side, growth slowed during this quarter.
We, however, continue to be generally opportunistic in the way we've grown the loan book. For example, the pipeline is relatively strong on the corporate side, and we therefore expect, if those materialize, growth to potentially pick up in the coming quarters again. The longer-term outlook, however, is very much impacted by the policy rate trajectory in Iceland, which continues to be a key driver for growth outlook in the economy. The loan book, of course, continues to be very well-balanced with 43% in mortgages, 5% to other loan to individuals, and 52% to corporates. Moving on to loss provisioning position. As discussed, we had just under ISK 1 billion impairment in the quarter or 27 basis points, driven primarily by Stage 3 exposures. Total loss allowance at the end of the quarter was ISK 12.8 billion or just under 1% of the loan book.
Non-performing loans ratio was flat during the quarter. This is a positive after having increased in previous quarters in close relation to the policy rates. Credit quality indicators are relatively robust, and we have, as discussed before, retained our conservative provisioning position based around comprehensive stress testing. As discussed in previous calls, the sector that we have perhaps been monitoring most closely recently, considering the environment, has been the construction sector. The housing market in Iceland has clearly slowed, which is to be expected with elevated borrowing costs and inflationary environment. This means that residential construction projects especially have been taking longer to sell, and this is, of course, a concern for the sector. This is a somewhat busy slide, but here we have provided some further disclosure of the lending in this area, which while being closely monitored, we are generally comfortable with currently.
Overall, the portfolio is around ISK 127 billion or 17% of our corporate loan book, with ISK 36 billion in undrawn commitments. I think firstly, it is important to note that out of this exposure around half is related to commercial construction projects, where in most cases there is a prearranged operator post-construction. These are thus not directly impacted by the slowing sales in the housing market. Secondly, in terms of the residential portion of the exposure, we are overall underweight in residential construction projects in Iceland, with market share of around 15%, which is well below our overall market share in Iceland in corporate lending. Third, I think it is also important that in terms of the residential construction book, around 34% of those are pre-sold and 88% of the projects are what we categorize as low to medium-term risk in terms of equity buffers of those projects.
And fourth, while in general the sales of the residential units has been slow, there has been a more robust activity in smaller size apartments, and this has generally provided contractors with a new project, with at least being able to partially sell down the project and allow them to reduce overall leverage in the projects. So at the end of the period, we have classified around ISK 7.5 billion in Stage 3 in total and have provisioned around ISK 3.3 billion for the portfolio. And of course, stating the obvious perhaps, but clearly all of these loans are well collateralized, and as such, there is a very remote risk of a full or even substantial loss on those exposures. Moving on to deposits.
As highlighted at the start of the presentation, deposits have continued the growth trajectory of recent quarters, increasing by ISK 33 billion in the period and now exceed ISK 1,000 billion. I think it is important to note, as I have described earlier, that deposit betas are high in Iceland. We are paying a lot for deposits, which is a headwind for our net interest margin currently. But then when policy rates come down, we also have a lot of room to move those deposit rates down as well to protect the margin. And finally, on capital, our position, of course, continues to be very robust with a common equity ratio of 18.5%, or 320 basis points above regulatory minimums. Clearly, of course, the capital generation of this business continues to be very robust, and we are generating around 80 basis points of capital per quarter.
But setting aside, of course, over 50% of those for foreseen dividends. As outlined earlier, we are refining our common equity target this quarter. The medium-term target is now 100 basis points-250 basis points, and we are guiding to a near-term target around the midpoint of that level. This, again, means that we have around ISK 15 billion of capital above the guidance, and as before, we will continue to optimize that through a combination of profitable growth, dividends, and share buybacks. And now I would like to welcome our Chief Economist, Erna Björg Sverrisdóttir, who will provide an update on the Icelandic economy.
Thank you, Ólafur. Good morning, everyone. We are in an economic crisis, at least in the minds of Icelandic households. We have only been this pessimistic twice before, during the pandemic and in the great financial crisis. Perhaps this gloom can be traced to the fifth wettest July on record in Reykjavík, or maybe the disappointing solar eclipse in August, which in typical Icelandic fashion, was lost to the rain. The economic environment likely matters more. Unemployment is rising, inflation is persistent, interest rates are high, and the economy is contracting according to the latest estimates from Statistics Iceland. GDP surprised to the downside in the second quarter, contracting by 1.1% year-on-year. Net trade was the main drag, with exports falling 7.3%. Mainly due to lower exports of seafood and aluminum.
However, in nominal terms, exports increased by 2%, again, primarily driven by significant price increases for seafood and aluminum. This underscores Iceland's position as a commodity exporter. Despite rising oil prices, our terms of trade have improved significantly. The export outlook for this winter and into next year has improved slightly. Aluminum production is back at full capacity, following the outage at Norðurál earlier than expected. Exports of ICT services have risen sharply in recent quarters, up by 73% in the first half of this year. Aquaculture is headed for a record year, with further growth expected in the years ahead. The path is a little steeper for our largest export sectors, primarily the seafood industry, which yet again faces a reduction in catch quotas and a disappointing capelin season, according to the latest estimates.
Tourism, on the other hand, has outperformed expectations, with tourist arrivals only down by 1% in the first nine months of this year. The solar eclipse in August provided a significant boost, as August has become the biggest month on record for tourist arrivals and spending per tourist. The outlook for tourism is broadly unchanged, but the uncertainty remains high as elevated oil prices affect airfares, air capacity, and global demand. At the same time, imports are expected to ease slightly in the next year, especially imports related to data center investments. Now, don't get me wrong, investment in data centers will remain substantial but decrease slightly between years. We also expect Icelanders to travel less abroad, as they have done this year, with trips abroad down by 9% in the first nine months of this year. This is consistent with other signs that households are becoming more cautious.
Growth in payment card turnover slowed markedly in the third quarter to 0.7%, pointing to a rapidly cooling private consumption. This is one of the key changes in our current economic forecast. We now expect slower private consumption growth than previously projected, and this, of course, is reflecting tougher conditions for households. The other major revision relates to investment, which we expect to fall considerably next year, particularly housing investment. Lower investments call for lower imports, resulting in a positive contribution of foreign trade to GDP growth next year. Overall, we expect 1.6% growth next year, which is a touch below the consensus at 1.8%. In this environment, falling investment, slowing economic activity, and just overall tougher operating conditions, it has had a clear impact on the labor market, which has cooled quickly in recent months.
Job growth has been weak with private sector employment falling. Job vacancies have declined. Firms have scaled down their hiring plans, and unemployment is rising from 3.5% a year ago to 4% this September, and it is expected to continue to increase at least until the mid of 2027. This increased slack in the labor market has cooled wage growth, which is at its lowest since the pandemic. Also, with parties agreeing in October to keep the collective wage agreements in force despite the review clause being triggered, a major source of uncertainty has been removed. Still, pay rises are too large and well above the level that is consistent with the inflation target. These steep pay rises, they have had a clear impact on the domestic portion of inflation, while a strong króna has helped to suppress imported inflation.
Therefore, headline inflation has proven persistent, measuring 5.9% in September. Even though higher headline inflation is to a large extent due to hikes in public wages and rising oil prices, underlying inflation has remained stubborn. To make matters worse, inflation expectations remain elevated and poorly anchored, necessitating a tighter monetary stance than would otherwise be required. The Monetary Policy Committee decided to raise rates by 25 basis points in August, taking key rates to 8%. However, the forward guidance and the tone of the committee softened significantly, and rates were kept unchanged in October. Analysts broadly agree that rates will remain on hold until next year before starting to fall as inflationary pressures ease and inflation itself subsides. That should offer some relief to the housing market, where conditions have been challenging. The supply of new housing has continued to accumulate.
The average time to sale for our newly built homes has grown significantly longer. Even though more homes in the capital area sell at a discount to the asking price, there are no clear signs of distressed sales or a rise in selling pressure. We expect nominal house prices to continue to increase at a very slow pace while real prices are projected to decline till mid-2028. Let me end this on a slightly more positive note. The foundations of the economy remain strong, and both households and businesses have shown remarkable resilience, supported by healthy balance sheets. That said, I would like to welcome Benedikt Gíslason, our CEO, to the stage to go over the operational highlights. Thank you.
Good morning. I would like to conclude this presentation by highlighting four key messages from this quarter. First, we have updated our capital management target, giving us clearer path for further capital optimization. Second, we continue to see growth, underlying growth, across our core operations. Third, while the economic environment remains challenging in some areas, our overall risk profile remains strong. As Ólafur went through, we have also significantly expanded our disclosure on construction and real estate exposures in this quarter. Fourth, we remain firmly focused on our cost discipline, even as we invest in technology and infrastructure to support the next phase of our growth. Starting with the capital, we have refined our medium-term target for the CET1 management buffer, as Ólafur went through. This does not represent a change in our approach to capital discipline or risk appetite.
Rather, it provides a clearer framework for how we intend to manage capital going forward. In the near term, we intend to operate in the midpoint of this new range. The CET1 currently at 18.5%. There is clear capacity for further optimization. We have already distributed ISK 25.6 billion during the first nine months through dividends and buybacks. Our approach remains to combine profitable balance sheet growth with capital distribution rather than treating the two as alternatives. The key message here is that our capital optimization plan remains firmly on track while the revised target gives investors greater clarity about where we intend to operate. Importantly, that capital optimization is supported by strong underlying performance across the group. That leads me to my second point, the emphasis on the continued growth in our core businesses. Given the interest rate environment, lending growth moderated during the quarter.
However, that should not obscure the broader progress we are making across the group. For example, core income increased by 10.6% year-on-year in the third quarter, while deposits continued a strong development, exceeding ISK 1 trillion for the first time. We are also seeing good underlying momentum across our business lines. In retail banking, Arion Rewards membership is up 33% year- to- date. The bancassurance ratio for individuals has reached 44.1%, and enrollment in Arion Future has increased by more than 20% since launching this targeted campaign. In asset management, institutional assets under management have passed the ISK 1 trillion mark. Third-party assets under supervision are above ISK 500 billion, and total group assets under management and supervision have reached ISK 2,161 billion. Vörður also continues to expand its insurance franchise, with insurance revenue increasing by 5.8% during the first nine months.
When we talk about growth, we are increasingly talking about growth across the entire group, not simply balance sheet growth. That diversification strengthens both the quality and resilience of our earnings. The third point I want to highlight is risk and asset quality. We maintain a cautious stance on the external environment amid continued macroeconomic and geopolitical uncertainty. The prolonged period of elevated interest rates, policy rates, is affecting some of our clients, and we continue to work closely and proactively with them. One area receiving particular attention is construction and real estate. Rather than simply stating that we are comfortable with these exposures, we have significantly expanded our disclosure so that investors can assess their composition and risk characteristics in much greater detail. Overall, credit indicators remain solid.
The NPL ratio was stable at 2.5% in the third quarter, and the bank continues to estimate long-term expected credit losses of 20 basis points- 25 basis points based on the current composition of the loan book. At the end of the third quarter, the 12-month expected credit loss ratio was 32 basis points, reflecting management's prudent view of current economic conditions. We recognize that slower sales of new housing represents a sector-specific risk. That is precisely why we have provided greater detail on project status, pre-sales, development stages, and stress testing. The message is not that these exposures are without risk. We recognize the slowdown in construction and housing absorption. However, we believe the exposures are well understood, diversified, and actively managed, and we want investors to have sufficient information to assess them for themselves. The fourth point I wanted to highlight is cost discipline in an investment cycle.
We remain focused on ensuring that costs develop below inflation, and that continues to be our guidance. At the same time, we are making targeted investments in areas that are critical to the future of the group, particularly artificial intelligence, core technology infrastructure, and cybersecurity. These investments are deliberate and disciplined. They are intended to strengthen resilience, improve efficiency, and create a capacity to grow without allowing the cost base to expand at the same pace. While we are investing through the current cycle, we remain firmly focused on operating efficiency. We expect these investments to support future growth and produce tangible benefits over time. Finally, before we move on to Q&A session, I want to draw your attention to our Capital Markets Day next March.
The purpose of the event is to step back from the quarterly results and give investors a deeper view of where we see the next phase of value creation for Arion. We intend to provide further detail on the development of our core businesses, our strategic priorities, and how we think about capital allocation and returns over the medium term. This is particularly relevant in the context of what we discussed today. We have a strong capital position and a clearer capital management framework while continuing to see attractive opportunities to grow the business. The Capital Markets Day will allow us to bring these elements together and provide a clear and medium-term view of how we intend to translate the strength of the Arion Group into sustainable shareholder returns. We look forward to discussing this with you in much greater detail in March.
With that, I welcome Theódór, our head of IR, and open up for the Q&A session.
Good morning, everyone. We already have a few questions from the online participants, and we will start with questions from Alexander at Akkur on the fees. Net fees fell 5.6% year-on-year with Markets and Stefnir lower, partly reflecting the timing of income recognition. How much of the Q3 shortfall is timing that reverses in Q4, and what is the underlying quarterly run rate?
Very good [audio distortion].
Yeah I can take this one. I think we had a comment on this on the slide. I think the point referenced more that this quarter last year. Can you hear me?
Yeah.
This quarter last year was probably unusually high. This business has been trending at around ISK 1.4 billion per quarter over the past year.
I think the guidance hasn't changed. There's always some fluctuations between quarters. Like I said, this quarter last year was very strong, unusually strong. Maybe this quarter this year is at the lower end again, but I think that this will continue to be at the sort of range that we've seen over the past few quarters.
Nothing.
It is related obviously to market activity and performance related fees.
Yes, but in reality, the SMS business is very much retainer based.
The fees have been very steady through the past few quarters.
The next question is on the proposed bank levy. How much of the increase do you expect the market to pass through to deposits or loan pricing?
It depends entirely on competition. I know the Seðlabanki Íslands recently published a survey where they asked the credit providers about their expectations for rate changes, for example, on the Markets product, and that indicated that some of this will clearly go through the lending side of the business. Competition will eventually decide who bears this cost.
Mm-hmm. Then, we have a question on our development asset, Blikastaðir. Where does the sale process stand? What is the expected timing following the conclusion of the first phase?
Yeah. We are currently in the second phase of this process and progressing. Hopefully we can update our investors on this in the near term. Yeah. That's the guidance that we can provide at this point in time.
Mm-hmm. Then we have two questions in a quite similar manner relating to the OpEx. Emil Jonsson at DNB Carnegie also is focused on or asking about the FTE development, as well as Alexander Baracozon tried to combine those questions.
Where do you see the FTE trend in the near term and the medium term? For example, do you see any reason to go back above 900 employees?
Mm-hmm. We have not provided any guidance on FTE. As I alluded to in my presentation, we are currently in an investment cycle. There are a number of key core systems that we are upgrading, and at the same time, we see opportunity to replace some of the legacy systems with our third-party systems with in-house development. Our guidance is on cost, and we are managing cost such that it is trailing the inflation in Iceland, which obviously currently is quite high. There is certainly cost discipline around our business and in particular on the investments, but we deem those quite essential to support our future growth.
We have a couple more questions from Emil at DNB Carnegie. You talked a lot about the deployment of capital and the changes in the capital buffers or excess capital, and capital targets. Can you help us understand the reason for the tightened capital buffer target and whether you intend to deploy the capital more through the additional capital distributions or through higher lending growth? Obviously, we talked about the combination.
Yeah. The reason why we are reassessing the target now is probably twofold. I think first of all, like I said in the presentation, this has been our target for a long time now, and we set this during the IPO in 2018 when we had a significant buffer above those levels, and we have actually had that for a long time now. We have been well ahead of the targets. Recently, we have been looking at the target now for some period.
The way we assess this is through a combination of we do our stress test, we have external stress test from the regulators. Then we have, of course, rating agencies. So we combine all these areas together and also look at benchmarks from, of course, other European banks. So, we felt this reflects the combination of those factors.
Yeah.
We also want the second point was that we also wanted to be a little bit more clear than we have been before around where we want to operate within this bracket, which is of course a relatively broad band. Of course, we will never be exactly where we're targeting, but I think we want to help an analyst to understand at least where we are aiming for.
So in the near term, that's the medium point.
Yeah. This hasn't been an issue prior, because we've had surplus capital.
Yeah.
But as we've moved closer to the management buffer, we felt that it was important to provide guidance on where we intend to operate within the management buffer.
Mm-hmm. On the way we are going to be using that surplus, I think we have been very active in buybacks. We've been optimistic in the way we grow the bank as well. So we'll use a combination of those as we have before.
Yeah. So there's not a strict percentage split.
No.
So it's more of if there are opportunities to grow the balance sheet.
Yeah. We found profitable growth opportunities also on the lending side there.
As that continues, we will continue to tap into that.
Mm-hmm. Then another question relating to the capital and the capital requirements. Do you see anything on the horizon that could lead to changes to your capital requirements or risk weights?
We are operating with standardized approach, and that is the upper range of where Arion Bank operates in terms of the risk weights. We do not operate any IRB models on any of our different credit portfolios. I think the recent changes in capital requirements, some of them have alleviated or relieved some of the capital that we previously deployed. Others have increased, especially, for example, on the construction side, where construction development carries now more capital. No, we are not faced with the IRB challenges that some of the Nordic banks are currently going through.
Yeah, maybe just adding, of course, the regulators effectively fully utilizing all the buffers they can now.
Yeah.
We don't have anything to guide on when that could be changing.
There's nothing.
Then the final question relating to our previous discussion is around can the market expect a new buyback program given that you are lowering the lower bound of the CET1 medium-term capital management buffer target?
Well, there's at least currently ISK 15 billion of surplus capital in our business. As we stated, we will be managing that in tandem with the growth opportunities that we see. So that's our guidance.
Yeah. That concludes our questions from the online participants. Are there any other questions we haven't covered in the auditorium? No? Thank you for the session today, and see you in three months' time. Thank you so much.