Good morning, and welcome to Íslandsbanki this Friday, where we present the fourth quarter and full year results of Íslandsbanki. I'm Bjarney Anna, with Investor Relations, and I'm joined today by our CEO, Jón Guðni Ómarsson, and our new CFO, Ellert Hlöðversson. Before I hand this session over to them, I wanted to mention that as per usual, we will have a Q&A following the presentation. You can participate in this session via the conference call using the dial-in details, and the operator will give you the floor. You can also submit questions through the platform or send an email to ir@islandsbanki.is. Guys, over to you.
Thank you, Bjarney, and good morning to you all, and thank you for joining this call on our full year results for 2023. Íslandsbanki had quite an eventful year in 2023. During the middle of the year, we had some internal changes, but then in the latter half, our attention was moved to the external environment, and especially the seismic activity on the Reykjanes Peninsula, where we have had quite a few earthquakes and eruptions almost monthly now for the past few months. This has had an impact on the small town of Grindavík, with just over 3,000 inhabitants.
Earlier this week, we had an eruption, actually, which had an impact on the hot water supply to a bigger community of about 30,000 people on the peninsula. But that's hopefully something that will be fixed in the next couple of days, and to bring life back to normal for those inhabitants. This obviously impacts a bit our results. We had a very good quarter with 11.2% return on equity, but having taken into account ISK 1.7 billion of impairments due to the activity in the Reykjanes Peninsula.
Without that impact, we would have had around 13.4% ROE in the fourth quarter, and just over 12% ROE for the year as a whole. As you can see, we have increased a bit our Stage 2 loans as a result of this as well, but overall, our asset quality remains very robust. In terms of our financial targets, we reached all our targets in the year 2023, obviously with return on equity well above the 10% target, and the cost income ratio well below the 45% target for the year as a whole, at 41.6%.
Core equity ratios remain very well above our requirements and also our internal targets, and Ellert will take you through that a bit later on. We are proposing a dividend of 50% of earnings, and we are also planning for a buyback program of about ISK 10 billion. Our guidance for the year, in terms of return on equity, is to be around 10%, assuming through-the-cycle impairments. There is some uncertainty regarding the net interest income item, especially due to a larger inflation imbalance and the impact of inflation and the real rates in the coming few months. At the same time, there's some uncertainty regarding the impairment account as well, due to the volcanic activity.
But the outlook remains quite good, and like we said, we are expecting around 10% return on equity, assuming through-the-cycle impairments. In terms of the economy, our economists are expecting a fairly modest growth this year. We will obviously see what the impact will be on tourism from the recent activity in Reykjanes, but overall, the outlook is very good, and industries in Iceland in general are doing very well. We are seeing the construction sector keeping on a fairly good pace in spite of the quite high interest rate environment. And obviously, Iceland is quite low levered, which helps in this environment, especially with the higher rates.
In terms of monetary policy, we have just recently had quite a low print in terms of inflation. So there are some encouragement there, and then some increased expectations that inflation will be coming down fairly quickly, and that we can have a reduction of interest rates in the middle of the year and possibly even earlier than that. In terms of the year of the whole, like I said, it's been an extremely eventful year. We had positive movements from both Moody's and S&P in terms of our ratings, and all business units did quite well. We have seen obviously a very strong market share in the SME sector.
Our chatbot, Fróði, has increased servicing more and more of our individuals directly and then without human involvement, and so we're seeing very good progress on that front. We have been leading in FX sales and also have been extremely busy on many fronts in terms of advisory and, for example, we have had a very good start of the year in terms of equity brokerage. Moving then over to special attention on Business Banking, which had a very good year last year, had about ISK 120 billion of new loans and about 19% return on equity and also seen a good growth in deposits.
Our car leasing arm, called Ergo, which is a part of our Business Banking unit, had a record year, some 20% increase in loans and a lot of activity in terms of loans to car renters, especially, which had quite a big growth in the car fleet during the year. So overall, a very good year for Business Banking, which enjoys a market share of around 40% in Iceland. On the digital front, we have seen quite a few wins and obviously continue to invest quite heavily on that front. The numbers speak for themselves.
We are seeing digital sales continue to increase, and we have been investing on our data journey quite heavily, and we'll continue to do so this year. We will be bringing a new online bank for corporate life this year as well. And earlier this week, we managed actually to launch corporate onboarding on fully digital for corporates here in Iceland, and already in the past couple of days, seeing a very strong pickup from there. So overall, a lot of things happening on the digital front all over. In terms of sustainability, we continue to be quite focused there and have high ambitions on that front.
We have now risk categorized 93% of our corporate credits, and we have been meeting with our clients both on the lending front and also our suppliers, and pushing them obviously to enhance on this front and do even better than before. I believe the dust is settling a bit on sustainability in terms of information sharing, and we obviously have in our accounts and in the annual sustainability report a lot of information about what the bank is doing on that front.
We have now measured, obviously, our loan book already in terms of where we see the carbon footprint, and our focus will now move towards where we can actually make a difference. What we see is that the biggest impact factor there is in terms of transportation. So we will look into that and see how we can work with our clients on that front. We also updated our sustainable funding framework late last year, and earlier this year, we issued our first issuance under the new framework, where we did issuance in Swedish krona and in Norwegian krone, and which was very, very well received by international investors.
Overall, very good results, and obviously, we'll open up for questions a bit later on, but I want to hand it over to Ellert to take you through the financials. Thank you.
Thank you, Jón Guðni. Overall, we're quite happy to present the results we have here for the fourth quarter and the full year results for 2023. Core income in the last year grew by 9.9%. At the same time, as Jón Guðni mentioned, the impairments came up as we saw Grindavík turning into an uncertainty, and we'll dig into that in more details. Return on equity for the quarter amounted to 11.2%, but should have been 13.4% if adjusted for the inflation impairment, sorry. Forgot to change the slide. Apologies. For the full year, return on equity was 13 point, 11.3% compared to a 12.1%.
In parallel to our annual accounts, we have released various risk reports, Pillar 3 reports, and all the material, which we direct investors to look at. Turning our focus into the net interest income, we are seeing a bit softening on net interest income in Q4 compared to Q3. That is mainly on the back of higher Central Bank reserves and loss related to the CPI imbalance, as Jón Guðni alluded to. NIM margins, looking on the lower left-hand side, reduced in the second half of the year from 3.2% in the first half to a 2.9%. During the fourth quarter, policy rates remained unchanged at 9.25%. Inflation, however, was subsiding. On Wednesday, the Central Bank announced a rate decision where policy rates were kept unchanged still.
Inflation ticks end of last year, in November and December, were 0.4% compared to a -0.16% in January, which is below analyst consensus. Throughout this year, we are forecasting that inflation will continue to subside and be approximately 5.2% on average on this year. Policy rates are forecasted to follow. However, as the loan portfolio has shifted towards a more CPI loan, or to a more CPI-linked loan, loan instruments, NIM is expected to become more volatile and pressured, given how, I would say, the coherence between the nominal rates and the inflation, how that pans out over the coming months. Turning our focus into fees. Q-to-Q, net fee and commission subsided a bit as volatile markets conditions affected asset management.
However, markets are starting to recover towards the end of last year and the beginning of this, so outlook is positive. Cards and payment processing was a big contributor to net fee and commission income in the last year. We saw a decline Q4, partly related to an expense, which to some extent should have been reflected in the full year figures, so we need to view this as a whole throughout the year. Allianz, as last year, as in 2022, was a good contributor to net fee and commission income. Overall, we're happy with the fee generation in turbulent markets. We saw positive turnaround in financial income towards the end of the year as markets started to recover.
Main contributor there is an appreciation of the liquidity portfolio as market rates are coming down. During this quarter, the bank has reclassified its bond position in the liquidity portfolio to a non-trading book from a trading book. This reclassification was approved by the Central Bank and resulted in less market risk and capital requirements in CRR. We have undertaken limited market risk exposure this quarter as previous quarters, as can be seen on the right-hand side of the slide, segregated between equities and bonds. The cost to income ratio in Q4 was 42.7%, which is within the cost to income ratio target of below 35%. However, comparison to Q3 will need to take into account seasonality, mainly related to salaries, as salaries are accrued throughout the year.
Looking at 2023 as a whole, OpEx rose by 13.6%, mainly on the back of general wage increase and inflation. Calculating the cost to income ratio, we are eliminating the administrative fine, both in Q4 2022, as well as in Q2 2022, sorry, Q4 2023 and Q2 2022, to provide a better going concern cost to income ratio comparison. As a result, the cost to income ratio in 2023 was 41.6%, which is flat from 2022 on the back of stronger revenue generation, which offset that the cost increases incurred through the year. Overall, we feel the cost is well maintained within the bank, and we are confident that we will continue to be within targets in the coming quarters. Then into the balance sheet.
Loans to customers closed off at ISK 1,223 billion end of last year, growing by 3% year-over-year. Business Banking was contributing the most, while we saw a slight deduction in Corporate Investment Banking, both in line with our expectations. Overall, loan book portfolio was well diversified, where mortgages account for roughly 40% of the portfolio. We have seen a slight pickup in construction, as Jón Guðni said, and we'll dig into that later on in the presentation. Credit quality remains good, and I draw your attention to the lower right-hand side graph indicating the segregation between risk classes. This is reflecting on the bank's rigorous risk culture and robust management practices. Year-end LTVs closed off at 57%, down 1 percentage point from last year.
Impairments are the second, is the other side of, of the loan book, and credit quality remains strong, looking at, looking at it from an impairment standpoint. Starting off with forbearance, we see loans in forbearance subsiding throughout the quarters as loans related to COVID went out of the 24-month period. Stage 3 loans remain flat throughout the last year at 1.8, 1.8%, while we see an increase in Stage 2 related to the seismic activity in the Reykjanes Peninsula. The bank has moved all its exposures with direct relations to Grindavík to Stage 2, which reflects the major change there, too. As everyone is aware, and Jón Guðni stated before, there is a lot of uncertainty in the Reykjanes area, so as a result, we have made some management overlays to the impairment model.
In the last quarter, we did a management overlay of ISK 1.7 billion, taking into account this uncertainty. The overall exposure to Grindavík is limited, roughly 0.4% of loans to customers. However, we can see from an impairment standpoint, should we have not impaired these additional ISK 1.7 billion, impairment reversals would have occurred on Q4. For the whole year, the cost of risk amounted to 8 basis points, compared to 33 basis points in Q3 on an annualized basis, given this management overlay. Taking further into the mortgage book, we can see the Stage 2 increase on the lower right-hand side, also related primarily to Grindavík. LTV for the entire book is 57% end of year, down 3 percentage points from last year.
On the top left side, we can see how the loan book is segregated between various loan products. There, we can clearly see the shift from nominal rate loans to either fixed or floating CPI-linked loans, as we have previously stated. This can be viewed as borrowers taking control on their financial health and manage their monthly payments through the high interest rate environment. During the year, ISK 38 billion are subject to rate refresh from fixed rate mortgages nominal. Next year, this amounts to ISK 56 billion. As inflation goes down and policy rates follow, we believe that this will pave the way for these, for these loans coming to rate reset, to be refinanced into various other loan products. Real estate and construction sector in Iceland is in good shape.
If we start with the real estate exposure, this amounts to 12% of our loan book end of year. These are primarily CPI-linked loans on the back of CPI-linked lease agreements those companies have with their clients, providing a natural hedge within their operation. Construction exposure has been growing slightly over the last year, where we can see off-balance liabilities turning into on-balance liabilities, reflecting how construction is taking place. Overall, 50%, roughly, of our construction is related to residential construction, compared to the other half through various sectors, as shown on the lower right-hand side. And then off to liabilities. Deposits remain the largest funding source of the bank, of around 46% of our entire funding need end of year. Deposit concentration is limited.
Ten, the 10 largest depositors owned 10% of the, of the deposit base, and a lot of this is within high liquid assets. We can see on the lower right-hand side that we have, that we have the largest depositors from, from individuals. Loans to customers closed off at - sorry, customer deposits to customer loans closed off at 144% last year, down from 150 the year before. Looking at debt issuances during last year, we were happy to receive our A3 issuer rating by Moody's, as well as a rate increase from S&P, from an A to an A+ last November. Maturity profile in 2024 is limited. The following years, the repayment schedule is also quite healthy.
This year, our ISK 500 million Tier 2 SEK bond is eligible for call, which we suspect, subject to market condition, will be called and refinanced with a second Tier 2 instrument. Sorry. Further, we will remain a regular issuer of domestic covered bonds, although in smaller numbers than last year. In the senior space, we will remain adaptive with regards to timing, spreads, and currencies. Liquidity is strong within the bank, closing off at 195% in total LCR and 115% in ISK LCR. The liquidity portfolio year-end amounted to three thirteen billion, which is roughly 20% of our asset base. Much of that is within level one assets. NSFR has remained stable throughout the year in the total numbers.
Lastly, turning our focus into capital. As Jón Guðni stated, year-end, the equity ratio amounted to 20.25%, compared to a regulatory requirement of 19.8%. Taking into account the increase in countercyclical buffer this March, the regulatory requirement will turn into 20.3%. At the same time, our MREL, MREL requirement closed off at 30.2%, while our ratio was eleven hundred basis points in excess, at 41.3%. Overall, our CET excess capital amounts to 620 basis points, and the total capital of 560 basis points. Given the management buffer current of 100-300 basis points, assuming the midpoint of that and our optimal capital structure, we have the ability to pay out ISK 36 billion from our excess capital accounts.
We will, in our next annual general meeting in March, announce a dividend payment of 12.3%, which reflects 50% of last year's profit in line with our dividend policy. Further, we will distribute CET1 capital amounting to ISK 10 billion through buybacks. Lastly, the bank aims to optimize its capital structure before year-end 2025, subject to market conditions. Overall, I can say that we are happy with the results we are presenting here today. Revenue generation was strong in 2023, return on equity was good and related to core operations. The credit quality remained strong as in previous quarter, as in previous quarters, reflecting on a cautious view taken on impairments. Lastly, our liquidity and capital positions are solid. With that, I pass the floor again to Jón Guðni.
Thank you, and over to you, Bjarney, in terms of questions.
Thank you, guys. We now open up for a Q&A session. You can participate in the session via the conference call button or the platform, and the operator will give you the floor. You can also submit questions in writing using the webcast form. Operator, are there any questions on the line?
If you wish to ask a question, please dial pound key five on your telephone keypad to enter the queue. If you wish to withdraw your question, please dial pound key six on your telephone keypad. The next question comes from Sofie Peterzens from JP Morgan. Please go ahead.
Yeah, hi, this is Sofie from JP Morgan. Thank you for taking my question. So, just maybe a follow-up on the last point that you made in the slide, that Íslandsbanki plans to optimize its capital structure before year-end 2025. Considering that you have over 600 basis points of excess capital, I know you want to do that, then we didn't share buyback this year. But how should we think about capital optimization? What will it entail? And yeah, basically, what are the different tools that you could use? And then my second question would be if you could just elaborate a little bit more on net interest income outlook. I think you mentioned that it could be quite volatile, given the link between the nominal rate and the inflation for the CPI-linked mortgages.
But when we kind of model net interest income for this portfolio, how should we think about the moving parts, and how will the inflation kind of impact that, the net interest income and maybe rate sensitivity and inflation sensitivity, if you have it? That would be all from me. Thank you.
Mm-hmm. Yeah. If we start off with the net, with the net interest income, what we have seen in the last year is a shift in the market or in the portfolio, where we've seen basically the composition change, where nominal rates went down by ISK 42 billion, FX went down by ISK 44 billion, while CPI-linked loan instruments went up ISK 128 billion. If we take into account, I would say, the funding sources, where a large part of it, as we stated before, is deposit-based, which are primarily nominally, nominally denominated accounts.
As a result, if we are seeing inflation subside, the inflation accounted for month by month will be subject to subsiding inflation and primarily fixed market rates or fixed real rates, which will then reflect into a more volatility as if we assume that the policy rates lag, to some extent, behind.
Yes. So in terms of the capital structure, we have obviously seen an improvement there, both on back of our earnings, so in terms of the excess capital, both in terms of our earnings and, but also, in terms of REA optimization. So we've made some measures there and seen quite a bit of benefit. So the excess capital is obviously quite substantial. It's over 600 basis points in CET1, and if we take into account our management buffer, as Ellert mentioned earlier, it's around ISK 35 billion, the excess capital. As we noted, we will start with a buyback program of ISK 10 billion, and we'll obviously conduct that possibly mostly through the open market purchases.
We will also then be looking into other possibilities. We can obviously have a additional dividend payment, or find other ways for buyback programs. We could also issue a T1 paper if we see the market there being constructive. But like I said, so at least we have the plan to start with the first ISK 10 billion, and then we'll see how the markets develop. And lastly, obviously, we could see some of it basically coming through growth in our loan book and asset growth. But I think the outlook there actually seems to be rather modest at the moment.
Obviously, with rather high interest rates, we expect to see yeah, not too high lending growth, at least in the coming few months. But then obviously we'll see as the interest rates come down, hopefully later in the year, that the lending growth could pick up in the second half. So overall, obviously, it's, we have now it's, it's, towards the end of last year that we hope to optimize the capital structure and starting with the ISK 10 billion buybacks for the next few months.
Thank you.
The next question comes from Piers Brown, from HSBC. Please go ahead.
Yeah, good morning. Just a few questions from me. One is on the ISK 1.7 billion impairment you've taken for the seismic issues in Iceland. I wonder if you can just give us some color on that. I mean, how precautionary is that impairment, and it sounds from the statement as if you're just being super cautious, and that the actual exposures against which that's been booked are quite small. So if you could just give us some color on, you know, the prospect of that impairment being reversed, as we go forward, if the seismic situation settles down. And then the second question is on the size of the buyback, the ISK 10 billion.
Can you just give us a little bit of insight as to your thinking around, you know, how you calibrate the size of the buyback? Is it primarily with a view to liquidity of the shares in the Icelandic market, or what other factors are you thinking about when you calibrate the size of the annual repurchase program? Thanks.
Yep, thank you, Piers. If I start with the buyback, so ten, so we are seeing basically based on the liquidity in the Icelandic market, and we can buy on a monthly basis of around maybe ISK 700 million. So that equates to you know 700-800, and that equates to then close to ISK 10 billion for a full year, but basically with open market purchases. And we think it's just a good start to start with the ISK 10 billion, and then obviously we'll see how the year progresses on that front. Ellert, maybe a bit on the-
Sure. The ISK 1.7 billion on the impairments related to Reykjanes Peninsula is basically a management overlay. We have always been and remain cautious in our impairment assessment. We believe that our portfolio is strong, it has strong security, it is a limited exposure, but from a cautious view, we thought this was the right figure to take into account at this point in time. The uncertainty is high, and we have seen volcanic eruptions, two of them actually, in January and now in February, which are causing difficulties in the Reykjanes area. The last one pulling apart the hot water supply to the entirety of the Reykjanes area. So we feel that this is a cautious view.
Of course, we hope that things pan out in a secure and successful manner, but, yeah, this was the approach now.
Mm-hmm.
Okay, that's very clear. Thanks very much.
As a reminder, if you wish to ask a question, please dial pound key five on your telephone keypad. There are no more questions at this time, so I hand the conference back to the speakers for any written questions and closing comments.
Thank you. We have a question here on the platform from Jóhannes Gísli Jónsson . He asks: Can you comment on how you see the loan book development going into the year, and break down the difference between corporates and individuals in terms of growth opportunities?
Mm-hmm. Yes, thank you, Bjarney. I think there's a bit of uncertainty now in terms of the loan book growth. It depends on the business environment, obviously, both in term, both in terms of the seismic activity in Reykjanes and how that will impact tourism, and also on the interest rate environment. So based on where things stand at the moment, we expect to see, I would say, modest growth in terms of corporate lending, both in terms of SMEs and large corporate as well. And when I say modest, I basically expect to see something in line with the nominal GDP growth. And on the market side, I would expect something similar.
There's however, when now a lot of customers are moving into inflation-linked products, it's possible that we will see some pickup in market share from the pension funds. So it's quite likely that actually we'll see some shift into these pension funds on that front. So overall, I would say it's a reasonable and rather modest growth that we are expecting over the past next few months, at least.
As there appear to be no further questions, we want to thank you for joining us this morning. We appreciate both you attending and raising the questions, and your commitment to joining our webcast this Friday morning. Have a good weekend.