Good morning, and welcome to Íslandsbanki this Friday, where we present the financial results for the Q1 of 2024. I'm Bjarney Anna with Investor Relations, and I'm joined today by Jón Guðni Ómarsson, our CEO, and our CFO, Ellert Hlöðversson. Before I hand the session over to them, I wanna mention that as per usual, we'll have a Q&A session following the presentation. You can participate in the platform and submit questions in the platform or use the conference link to ask questions through the conference call. You can also submit questions in writing using our IR email, ir@islandsbanki.is. Now, the floor is yours, Jón Guðni.
Thank you, Bjarney, and thank you for joining this call on this rainy morning here in Iceland. We are experiencing a rather mixed environment, both on the business side and the economic environment as well here in Iceland. We are seeing general business investment being rather benign, but at the same time, we're seeing a pickup in investment in housing and the housing market picking up in general. The outlook is fairly good, but at the same time, we are seeing that some of our customers are experiencing the higher rates are having an impact. But we are not seeing impact on that in terms of delinquencies or the quality of our loan book, at least to a very small degree.
So like I said, a bit of a mixed environment. If you look at our results for the Q1, we had a 9.8% return on equity, which is in line with our guidance, which was around 10%, and slightly below our 10% target. The cost-income ratio was below our target of 45%. The Q1 is generally fairly high in terms of costs, for example, in terms of leave and some other cost items, so a relatively high cost-income ratio in this quarter. The capital position remains very strong, and as Ellert will describe later on, we had the opportunity to go into further buybacks this year.
As I noted, the asset quality remains quite robust, even though, like I said, we see that some of our customers are feeling a bit of the pain of the high interest rate environment. And some of them are using the opportunity to move over into inflation-linked products. In terms of, like I mentioned, our guidance for the year remains to be at around 10% return on equity, and the cost-income ratio obviously below 45%. And in terms of the capital, we are quite well overcapitalized and well above our targets. In terms of the economy, we are seeing GDP growth coming down quite a bit from last year.
Last year, we had some continued pickup, basically from the COVID era, and so now we are seeing basically a normalization, I would say, in terms of the growth, and obviously with the higher interest rate environment, the central bank is doing its part to cool down the economy. So we expect growth around 2% this year, and then reach more normal levels the year after, of around 2.5%. The housing market has been slowing down over the past few months, I could say.
Then last year, for example, price increases were very modest, and we felt quite a sharp cooling in the last quarter of last year in terms of new construction projects, but we are seeing that picking up now. The seismic activity in Grindavík has had a bit of an impact on the market, where the inhabitants of the town have been going into the market, and so we see more demand, and that seems to be also pushing for new construction projects, which we have been seeing starting now.
Like I said, we obviously are running at a quite a high interest rate environment, where the central bank rate is still 9.25%, and the market is not expecting a decrease until probably in the Q3 or even the Q4 of this year. The annual inflation now is down to 6%, which means that we have the real rates of around 3.25, so quite high real rates, and this is obviously impacting some of the investment levels. Quite sizable impact on our earnings as we are running an inflation imbalance, where we have more inflation-linked assets than liabilities, as Ellert will describe a bit more later on. So we can see some fluctuations in our earnings due to this interest rate environment.
Moving ahead, in terms of the Q1 for the bank, like I said, it was a fairly strong activity in on many fronts, especially using the housing market picking up. In terms of business-wise here, our corporate finance unit is quite active at the moment and is now preparing the listing of Íslandshótel, a hotel operator here in Iceland, which will obviously be exciting to see, hopefully in this quarter. In terms of our capital markets activities, we have a very strong position now with the in terms of equities, with the highest market share so far this year. We continue to make quite substantial investments in our technology and our chatbot.
We got nominated for two international awards in the Q1, which we obviously are very happy to see, and we continue to develop that quite rapidly. And at the same time, we are also working on an internal chatbot based on generative AI, and that's in beta testing already, and will be a new tool basically for employees to use, obviously, to help them in terms of their work. So, quite a few activities, and then obviously the biggest news from the quarter was the increase in the rating or the rating upgrade from S&P, moving us to BBB+ which we are obviously extremely happy to see.
In terms of infrastructure, we see a lot of opportunities in infrastructure here in Iceland, and ample opportunities there in the years ahead, and quite a big investment needs on that front. The road systems, obviously, and bridges, the energy transformation, for example, with wind farms, and on many other fronts, airports, telecommunication, and so we are seeing this in the hundreds of billions ISK in terms of the investment need for the next 10 or 20 years. Here we can play a crucial part both with our balance sheet, but also with our services, corporate finance, funding, FX and bond issuance.
And here we plan and can definitely make a, a, will be a force for good and have a positive impact on the local environment here in Iceland. We also want to note that we own a plot here in Reykjavík, where we used to have our old headquarters called the Kirkjusandur. We have now finally decided that we are not moving our headquarters back to this plot, and therefore we have changed the accounting method and moved this into basically fair value, you could say. And seeing a bit of an impact on our earnings as a result in the Q1, which Ellert will describe a bit later on.
But in terms of the plot itself, it's an extremely good location in Reykjavík, a good opportunity, about 26,000 square meters, a number of apartments, around 200-250. And we are now basically in the final stages of development and plans for in terms of the potential sale of this plot going forward. So for the domestic investors here in Iceland and obviously others here, I think this will be a very interesting opportunity. We are now quite focused on financial health. Based on, we have been seeing that our customers are increasingly worried about their financial health due to the high interest rate environment here in Iceland. And that's probably something that we're seeing internationally as well.
And here we can actually play a fairly big part, and therefore we are promoting in our messaging outwards. First of all, we are beefing up our education on this front. We are making our advisors more accessible, where customers can book time slots to have discussions, and we are also adding activities and services in our online channels, and we'll also be developing more products to help customers on this front. Not only are we looking at financial health, but also physical and emotional. On the emotional front, we want to continue to make Íslandsbanki a great workplace, and focusing our efforts on that quite substantially on many fronts, promoting health in general across the workplace.
Externally, we have the Íslandsbanki Reykjavík Marathon, which is the biggest charity event of the year, and that's something that we are now starting to promote for the summer, and obviously both internally and externally as well. So having gone through that and some of our plans for the next, the coming months and the general environment, I now hand it over to Ellert to give you a bit more detail about the financials of the bank.
Thank you, Jón Guðni. Turning over to the financials. Profit for the quarter amounted to ISK 5.4 billion, and return on equity 9.8%, as Jón Guðni stated before. Year-on-year, the operations were impacted by fixed rate imbalance, the CPI imbalance, and also fixed rate reserves for the NII. During the quarter, as stated before, we reclassified Kirkjusandur, the plot we owned, as investment property and realized a fair value gain of ISK 900 million. We are exploring to what extent we will be developing further, and we'll provide updates as things mature. We experienced unfavorable market conditions, which were leading to high effective tax rate of 31.3%. This is primarily due to loss related to equity holdings used for hedging against forward contracts.
But if you look at the NII, as I stated before, the fixed rate imbalance and the CPI imbalance continue to have adverse effect on performance. Further, the Central Bank raised its fixed rate reserves from 1% to 2%, effective June 2024. This April. Given the current rate environment, each percentage point is estimated to have a cost of over ISK 900 million. Despite this, we see an increase in net interest margin quarter-over-quarter, that is, from Q4 2023 to Q1 2024, where margin grew from 2.9%-3%. During the quarter, the policy rate remained unchanged at 9.25%. Inflation, however, varied, going from 0.4% to -0.16%, up to 1.33%, accounted for in March.
Analysts assume that inflation will continue to subside and policy rates will be cut, followingly. As stated earlier, and Jón Guðni touched on before, given the current loan pool composition, we expect that income volatility may be experienced while this trickle through our books. On the fee side, cards and payment processing remain the largest net fee and commission income. Although, the cost related to payments has gone up, impacting year-on-year comparison, which is mainly related to scheme fees. Investment banking and asset management, fee income continues to be pressured due to market conditions. Advisory pipeline, however, remains strong, and capital market valuations support overall positivity. In addition, we would like to mention that Allianz, our insurance subsidiary, is turning out quite a healthy contribution to the net fee and commission.
Market conditions also affected the net financial income during this quarter. As stated before, we are experiencing a high net tax rate or effective income tax rate related to economic hedging. Further, market conditions unfavorably affected bond yield, bond yield curves. As before, we have limited market risk exposure on our books, amounting to ISK 5.1 billion end of quarter four for listed shares, compared to ISK 2.3 billion end of the year 2023. Looking at cost, cost to income closed at 44.7% within our targets of 45%. Year-on-year, expenses rose by 5% and amounted to ISK 7.4 billion end of the quarter. Salaries were growing 5.2%.
That is mainly on back of additional employees hired year on year, which is, with regards to our ongoing commitment to further strengthen our regulatory infrastructure and overall governance. In addition, we have made, provisions within the quarter related to the expected outcome of the general wage union agreement, which have not been concluded for the union, to which, our employees reside. We would also like to note that there is a seasonality as before in our, in our salaries, where accrued leave, is being accounted for in the first half of the year and then being, then being, reversed during the summer. Than the second half, sorry. Turning to the balance sheet. Loans to customers closed at ISK 1,248 billion, growing by 2% from year-end 2023.
During the quarter, all business segments were growing, while CPI was growing the largest by 3%. As before, the loan book is well diversified. 43% of the book is in mortgages and individuals additional 5, 5 percentage more. The remainder is well diversified between industries. A gradual increase has been seen with construction, which we'll touch on later on. The bank has a conservative credit culture, which can be reflected in the risk classes on the lower right-hand side, where our borrowers tend to reside in the lower risk classes. Average LTV closed at 57%, flat from previous quarter, despite high interest rate and high inflation. Cost of risk was 23 basis points during the quarter, within our guidance of 25 basis points throughout the cycle, given the current loan book composition.
A total of ISK 700 million to any significant, at this point in time. Stage two loans remained flat at 3.3% during the quarter from year-end 2023. To recall, stage two loans were increasing from Q3 to Q4 in 2023, which was mainly due to the seismic activity at Grindavík, where uncertainty is still high. Stage two, however, remained stable, growing by 0.1 percentage points from 1.8% to 1.9% within healthy limits, providing an overall good asset quality reflection. Taking into the mortgage book, credit quality also is good at that front. Stage two and stage three remain flat quarter-on-quarter, having increased, as stated before, in Q4 2023, based on, the activity in Grindavík, the seismic activity.
As previously stated, we are seeing a continuous shift where borrowers are refinancing the mortgages to CPI-linked instruments. This is a way for customers to manage their repayment profile. As of now, 56% of the mortgage book is within... compared to a position of ISK 129 billion end of 2023, both on the back of mortgages as well as corporate loans and other loans to individuals. On the other hand, interest rate resets for 3- and 5-year fixed mortgages are ongoing, relieving the fixed interest rate imbalances within the banking book. On the upper right-hand side, you will see that a total of ISK 29 billion are up for reset throughout the remainder of this year, compared to ISK 9 billion, which was accounted for in the Q1. Next year, subsequently, ISK 52 billion are up for reset.
All in all, the mortgage book is in a healthy shape. NPLs are low, and LTVs remain flat as before, given, even though we have high interest rates and high inflation. Our exposure towards real estate and construction grew by a total of 3% during the quarter, and amounts to 12% and 7%, respectively, of the loan book. As spread on primary issuances or capital markets domestically comes down, some of this exposure may be refinanced to the capital markets. Despite commercial real estate being pressured on both sides of the Atlantic, the Icelandic sector remains strong. Occupancy ratios are high, and the listed companies are reporting an occupancy ratio of around or over 95%, with a natural hedge. On the construction side, we would like to emphasize that that disbursements of loans are linked to progress in construction.
Further, half of the exposure relates to residential real estate, where analysts forecast increased demand. Also liabilities. Deposits remain the largest funding source for the bank, as previous years, at 48%, end of the quarter. Deposit concentration is stable, where 11% of the deposits belong to the 10 largest depositors. Over half the deposits are related to individuals, so ISK 443 billion, growing 4.2% since year-end 2023, while other segments remained flatter. The funding is off to a good start. At the beginning of the year, we issued a 3-year NOK 500 million and SEK 500 million senior preferred green notes, and in March, a new 4-year EUR 300 million bond, which was issued at 185 basis points over mid- swaps, considerably tighter than the previous 2 years.
In addition, we issued ISK 5.3 billion, five-year senior, senior preferred in the domestic market. As a result, our FX funding requirements for this year have been well advanced. During the year, a SEK 500 million Tier 2 is expected to be called at the first call date. No decision has been made on issuances in the Tier 2 space, given the strong capital position. In early April, S&P announced a rating action, raising our, our rating to a BBB+ on a stable outlook. This was primarily based on the back of recent rating actions locally and domestically. In terms of liquidity, the bank has a strong position where total LCR is 190%, and the LCR for ISK closes at one, at one oh one, at a hundred and one percent.
NSFR remains stable throughout the period. Our liquidity portfolio amounted to ISK 325 billion, representing 20% of our total asset base. Start of the quarter, we reclassified the liquidity book so that it's now held mark-to-market at fair value through OCI, compared to a fair value through PNL, which was classified before in 2023. This better reflects how the liquidity portfolio is being managed. Assets within the book that originate from 2023 will not be reclassified to go over OCI, but new assets will go through OCI. As before, the entire book is held at mark to market, and there are no unrealized costs due to mark-to-market movement in the book. Lastly, turning to capital.
Our total capital ratio closed off at 23.8%, compared to a 25.3%, year-end 2023, where deduction planned, 10 billion ISK related to buybacks played the larger part. Paving the way for additional CET1 disbursement. At the end of Q1, CET1 position was 420 basis points ahead of requirements. Given the management buffer or the current management buffer, there are ample, opportunities for disbursement of excess capital. During the quarter, an AGM decided on a 12.3 billion ISK, dividend payment, which was paid on the second of April. Further buybacks are also occurring. The bank plans to optimize its capital position before end of 2025.
To that extent, the bank may, in addition to internal or external growth, explore capital distribution in the form of ordinary share buybacks, buybacks via reverse auction, and/or extraordinary dividends in order to reach its target capital composition. With that, I hand it over again to Jón Guðni Ómarsson.
Thank you. Just to sum up, our results for the Q1 are in line with our guidance for the year, and our updated guidance for the full year is in the same line at around 10%.... The Icelandic economy seems to be on route for a soft landing, with a bit mixed business environment, as I described earlier. Íslandsbanki is very well placed in this market, and obviously to reap the benefits from an uplift in the economy and in the capital markets that we're expecting when the interest rate levels start to come down. And as Ellert described, we are planning on further capital optimization in the coming few months.
Having said that, I think we should move over to questions. Over to you, Bjarney.
Thank you, boys. We're now open for Q&A session. You can participate in the session via the conference call, and the operator will give you the floor. You can also submit questions in writing in the webcast form or send us an email. Operator, are there any questions on the line?
If you wish to ask a question, please dial pound key on your telephone keypad to enter the queue. We'll have a brief pause while questions are being registered. The first question comes from the line of Sofie Peterzens from J.P. Morgan. Please go ahead. Your line is open. The next question comes from Sofie Peterzens from J.P. Morgan. Please go ahead.
Yeah, thank you for taking my question. So, you mentioned that the Basel IV could be a small positive impact or a positive impact lead to lever risk credit assets. Is there kind of can you just update us on the latest with the government stake? And yeah, if there is any update here, and did you do a directed share buyback to the government as you continue with your capital optimization?
Okay. I can think and start with the in terms of the buybacks and the government stake. All buybacks that you plan would be diverted towards all shareholders, not particularly towards the government, just open to all shareholders. In terms of the government stake, there's a bill now before parliament in terms of giving the Ministry of Finance the authority to continue the sell down, and we are hoping that that bill will pass in the next few weeks. And the government has stated its intention to sell probably half of the remaining stake during the course of this year, and the other half next year. Then Ellert, in terms of Basel IV, over to you.
Yeah. In terms of Basel IV, I mean, preliminary analysis is taking place. We have been going through it, and it's... I mean, the amount is measured in, I would say in, in tens of billions ISK, 50-ish. But since, nothing has been imposed into, into regulation, there's still uncertainty to what extent, I would say, especially mortgages will be reflected in the Icelandic legislation, which may have a meaningful impact on, to either side.
Okay, that's very clear. Thank you.
As a reminder, if you wish to ask a question, please press pound key five on your telephone keypad. The next question comes from Piers Brown, from HSBC. Please go ahead.
Yeah, good morning, everybody. I've got two questions. One is on the CPI imbalance. I don't know whether you actually gave the number that's embedded in net interest income this quarter, but I'd be interested to hear if you have. There's a figure on page 12 of the slide pack of minus, I think it's 168 for other items in NII, but if you could just clarify if that's CPI. And then the second question is, in the press release, there's reference to an anti-AML case that you may need to settle, potentially book a fine for. If you could just quantify, is that something that could be material for our modeling purposes? Thanks.
Okay. So I'll start with the AML. That's actually something we described, I think, in, you know, Q4 results, and then again now, basically in the notes. And this is basically an outstanding item, and we have actually already met all the requirements from the regulator in terms of changes. That has been implemented already. However, they will be coming formally out probably in the next few weeks or a couple of months with the final results. And it's hard to say whether it will be a fine, and at the same time, it's also extremely difficult for us to quantify there.
But like I said, we have not seen any particular, or we haven't experienced any money laundering through the bank, no evidence of such, and at the same time, we have already met the requirements from the regulators. So we certainly hope that that will have a big impact on any potential fine amount. Then in terms of the CPI imbalance, Ellert, over to you.
Yeah. First off, on the AML issue, within the contingency note, we state that we have provisioned an undisclosed amount, relating to a potential fine, just to add that. On the CPI amount, there was a slight loss during the quarter, or a slight calculated loss during the quarter, measured, I would say, somewhere midway between ISK 0-100 million.
... Thanks for that, Ellert. Can I just follow up? Could you just talk through the mechanics this quarter of the CPI, why that's a negative item within interest income?
Well, this has much to do with how we calculate things. Obviously, we fund the CPI more. The CPI loans are primarily funded with nominal deposits and nominal issuances. So, how we account for these things with regards to, I would say, the loss of opportunity, to some extent has a big part to play with it. If you look at the imbalance itself, it has been growing, so you can't really view it as, I would say, it's in a steady state. But I think it could be, I would say, beneficial for all analysis if we provide, I would say, some actual material detailing how this goes through our books. It's kind of difficult to go through the mechanics during the webcast.
Yeah, so maybe just, as a very-
Yeah, I appreciate that. Yeah, I'm just-
Just a very brief example. You know, if nominal rates are at around 10%, and real rates around 3%, obviously the risk is now for the short term, is that the nominal rates stay at a quite high level, while inflation starts to come down. So for example, that inflation example, if inflation then goes down to 5%, then the overall impact, so then we have, you know, 3% real rates plus 5% inflation at 8%, and that we... There we can see a temporary loss. And then obviously, we to mitigate against this as well.
Yeah, and if I add a bit to that, I mean, high inflation is no new, that's not news to Iceland. We have traditionally had high inflation, we have had high interest rate environment going up and down in cycle all throughout our economic history. This is something which we have seen before, and we know how to manage it. We're taking a balanced approach, and we'll provide some material to the analysts detailing how this goes through our books.
Okay, that's very helpful. Could I just... One final thing on that. If I look at the balance sheet and the, so the reported loans to customer number, which I think has grown 2% quarter-on-quarter-
Mm-hmm.
presumably that's impacted by, effectively revaluation of the CPI-linked loans. Is that correct? I mean, is it possible to figure out what the underlying rate of growth is if you strip out the CPI impact on the balance sheet?
Mm-hmm. Yeah. This is adjusted for inflation, so high inflation goes through as higher end-of-quarter position.
Yeah. We can certainly provide that to give you a bit more details on how much of the growth is through the inflation versus real growth.
Okay. That's very helpful. Thanks a lot.
There are no more questions at this time, so I hand the word back to you, Bjarney.
Thank you so much. We haven't received any written questions, so we're concluding this session, and we thank you all for joining and hope you have a good weekend.
Thank you.
Thank you.