Good morning, all, and welcome to Íslandsbanki this Friday, where we present the financial results for the third quarter of 2023. I'm Bjarney Anna, Investor Relations, and I will be moderating today's session. I'm joined by our CEO and acting CFO, Jón Guðni Ómarsson. Before I hand the session over to Jón Guðni, I wanted to mention that as per usual, we will have a Q&A session following the presentation. You can participate in the session via the conference call using the dial-in details, and the operator will give you the floor. You can also submit questions in writing using the webcast form, or email us at ir@islandsbanki.is. Now, over to you, Jón Guðni.
Thank you very much, Bjarney, and thank you all for joining this call. Íslandsbanki had robust earnings in the third quarter of 2023, and we are happy with the results in a relatively mixed business environment. We are obviously seeing quite uncertain times abroad. Here domestically, the economy has been going quite well, very strong tourism season. But at the same time, we have quite high interest rates and high inflation, and we have now national agreements coming up in terms of salaries across the board here in Iceland, so some uncertainties here in the environment.
We saw good growth between the years in net interest income, but a bit of a reduction in fee income due to very turbulent markets, and the markets here in Iceland have been quite soft and softer than we have seen internationally, probably due to the fact that we have seen interest rates here go a bit further up, and the Central Bank rate is now at 9.25%. The cost income is well below our guidance and targets, at 39% in the third quarter.
That's a bit... In the quarter, we see a bit of a seasonality as we accrue salaries or leave all the other months of the year, and taking that through revenue in the third quarter, and therefore, the cost in the third quarter is usually a bit lower than in the other quarters of the year. You know, the deposit base has been growing quite steadily, as you can see at the bottom, left here, and we're obviously extremely happy, especially to see good growth in retail deposits.
At the same time, asset quality has remained very strong, and even though we have this high interest rate and inflation environment, there are, however, certain signs that some of our borrowers obviously are starting to feel a bit of a pressure from this environment, and we are seeing quite a few borrowers moving into inflation-linked loans to reduce their monthly payments. If you look at our targets, we have met all of our targets in this quarter, obviously, in terms of return on equity and cost income, and we have, as I'll describe a bit more later, capital buffers obviously well above our targets.
In terms of the economy, we are seeing fairly strong growth this year, probably around 2%, and expect to see similar growth next year, and the biggest driver is the tourism sector, which has been picking up quite, quite well after COVID. The housing market, which was flaming hot, you could say, a year ago, had been rising over 20% year- on- year, has now moderated, and we have actually seen a close to 0% real change or even a bit of a reduction over the past 12 months.
What helps us, obviously, in this environment is that Iceland is moderately leveraged, and you can see at the bottom left here, if you compare to the Nordic countries, and the comparison obviously looks even better if we compare to many European countries in general. But as I mentioned before, our main challenge at this time is the inflation, which is running quite high, and then the interest rate level at the same time. The Central Bank has been quite active in raising rates quickly to fight against inflation. The main driver of inflation has been rising housing prices and obviously imported inflation.
We believe that both of those are moderating, but the question is now more in terms of internal wage increases or domestic wage increases. All of our business units did very well in the quarter. As you can see here, very strong earnings across the board. The average earning for the bank is obviously lower than we see for the profit units, and the reason being is that all our excess capital, which is quite substantial, sits within Treasury, idly, you could say. And that's obviously, as we have noted before, we plan to optimize the balance sheet structure and the capital structure before the end of next year. Over to you, Bjarney.
Thank you, Jón Guðni Ómarsson. Like in other countries, customers in Iceland are increasingly experiencing fraud attempts online or in digital channels. Obviously, we take these increases seriously and do our best to raise awareness through training and education, thereby hopefully limit the number of instances customers experience fraud. We have also implemented numerous ways to limit the effects of fraud, including requiring customers to confirm an online purchase through a customer-specific electronic ID, implementing a solution where customers can sign out on multiple devices with one click in the case of a security threat. Lastly, we offer our customers around-the-clock service to assist with fraud when they come up. These increased services have been very well received by our customers and is a clear indicator that this is a real concern. We're constantly working on ways to increase and enhance customer services while also promoting efficiency.
Fróði is a great example where this goes hand in hand, and to think Fróði, our friendly chatbot, is only three years old, and already with his long list of achievements and award is remarkable. To give an example of Fróði's ability, he now answers more than half of all customer service chats. He consistently gets positive feedback from our customers, some even doubting that Fróði is a program and not a living person. Alongside the evolution of Fróði, we've implemented an innovative solution based on natural language processing in partnership with Miðeind, an Icelandic AI and NLP innovation company, giving us the opportunity to strengthen and preserve the Icelandic language in an increasingly digital world, and thereby being a force for good. Speaking of being a force for good in society, Íslandsbanki supports the blossoming startup and entrepreneurial community in Iceland in various ways.
One way is through our entrepreneurship fund, where we are now accepting grant applications for the annual allocation that will take place before the end of the year. The fund has, in the last three years, awarded ISK 165 million to projects that support the four UN Sustainable Development Goals the bank has chosen to focus, displayed on the slide. The bank contributes a part of the annual balance of Vaxtasproti savings account to the fund, and I'm really looking forward to seeing the list of projects that receive an allocation later this year. Now to an annual event held dear by many. It was a glorious day in August when we celebrated with more than 11,000 runners and walkers during Íslandsbanki Reykjavík Marathon.
The day was a huge success, and it only made our smiles bigger when it was clear that ISK 200 million were raised for charities by the participants, a record amount for fundraising alongside Íslandsbanki's Reykjavík Marathon. Now over to Jón Guðni for a more in-depth encounter of the financial results.
Thank you, Bjarney. I ran the marathon, the 10K, with my 14-year-old daughter. Not my best time, I think it was 1 hour and 20 minutes, but definitely quality time with a teenage daughter. Not often you get, you know, that amount of time to speak to teenagers, so it was a great time and a great event across the board. Now moving on again to the financials. When we look at the bridge between the years in terms of the earnings, as you can see here, net interest income has obviously gone up, but the main disadvantage obviously has been operating expenses have also been going up due to wage increases and increased inflation.
Net impairments obviously show a negative impact in this quarter, where we had a positive impairment last year, so quite a big change there. And that's the largest contributor to the change between years. If we look at the net interest income, on the right side, you can see that we have seen the same trend as over the past few quarters. Lending and deposit volumes still going up, and the lending margin obviously reducing a bit as rates go up, but the deposit margin has been quite stable. The deposit beta has been quite high over the past few weeks and quarters, basically, as the rates are now at a quite high level.
As I noted before, and in other interest, ISK 185 million, there we see the benefit of the higher rates environment, but when we compare quarter-on-quarter, so the second quarter of this year to the third quarter, we see a bit of a drop. The reason being there is that we are a bit long inflation, and the inflation, even though it has been quite high, it was actually running at 9% in the second quarter, but only 5% in the third quarter. So that explains kind of big part of the drop there between quarters. Also, we have seen an increased reserve requirement from the central bank, and also some increased costs of FX liquidity.
So looking ahead, we expect that the interest margin will probably remain at a fairly stable level, at around 3%, now slightly below that level. In terms of the fee income, like I mentioned earlier, a bit of a drop there, and the main reason being investment banking and brokerage, and that's usually just due to very turbulent capital markets. The assets under management have come down, obviously, as a result of the negative earnings and negative impact from markets. But hopefully, we are now seeing the markets recovering and seeing an increase going forward on this revenue item.
At the same time, however, cards and payment processing continue at a healthy rate, where we have seen, obviously, Icelanders travel abroad quite substantially. The net fee income is... no, sorry, the net financial income, we have seen, see at the bottom left here, the factors behind that, the biggest item is the shares and related derivatives, if we look at those in isolation. Again, obviously due to the turbulent markets here over the past few weeks. Then we have bonds and related derivatives and other derivatives which net each other out to quite a large degree.
So the shares and those derivatives are, you know, the main contributing factor here. In terms of the cost income, again, we are obviously well below our targets, in a very good place there in terms of the cost income level. Costs, however, are running quite high this year. We have pretty much the same number of FTEs as we had last year, but obviously, looking forward, we will be looking at possibilities to continue to increase efficiencies on that front. We have invested quite substantially this year in strategic projects, with consultants working with us on various fronts. Then also, we have seen quite increased AML costs.
We are strengthening our defenses and increasing our team on the AML side and the KYC. So that's something that obviously we have to look into also going forward, how we can increase the efficiency on that front. In terms of the lending growth, we saw quite strong growth in the first half of this year, but a bit of a reduction in the third quarter.
The reason being that, firstly, we have seen some reduction in the market share in foreign currency lending here domestically, where we've seen, due to a bit higher cost for the Icelandic banks, some foreign banks gaining a bit of a market share there, which is something that we have seen before in this kind of environment and will hopefully moderate quite soon. Then, we also see a bit of a seasonality in the car loans in Ergo, where obviously they peak during the summer months, and then they start repayments in the fall as the tourism season winds down. The pipeline is now quite strong, and so we expect to see, you know, reasonable growth in the fourth quarter.
In terms of the impairments, the impairments this quarter were largely due to a single credit case, which is quite specific. We are not seeing any specific sectors or any clear indications or worrying signs in specific sectors of the economy. Overall, our borrowers are doing quite well, but high rates and inflation are obviously having impact on their earnings. Like I said, we are not seeing any increase in non-performing loans as of yet. The mortgage book, we have seen quite a bit of a shift now into CPI loans there. That's obviously a product that has been around here in Iceland for 40 years and is quite common.
A lot of our borrowers moved into non-inflation linked, just regular, loans, many on fixed rate, in the past couple of years, especially as rates went quite far down during COVID. But now, the normal rates have gone back up and obviously at a quite high level, so some of our borrowers see the benefit of moving into inflation linked to see their monthly payment reducing. As you can see on the top left here, we are seeing quite a steady flux into that product now, and we expect to see that in the months ahead as well. In terms of the real estate sector, that's doing quite well as well.
That sector is, however, slowing down, and that's obviously part of what the central bank has been doing. That's basically to raise rates to cool down that market, but overall, our borrowers there are doing quite well. Can you maybe move the slide? Thank you. In terms of deposits, like I mentioned before, we have seen a steady growth there, and particularly good to see the growth in the individuals and the retail deposits. In terms of the borrowings, we have now basically finished our maturities this year. You can see the maturities on the middle of the graph, and then we have basically very stable maturities over the coming years in line with our policies on that front.
We are extremely liquid at the moment, and excessively liquid, you could say, with ISK 370 billion of liquid assets and with liquidity ratios running at an extremely high level. And so that's something that's a part of the optimization exercise in terms of our balance sheet that we will look into in the coming few quarters. But obviously in a bit of a mixed environment now, it's good to have strong liquidity. Same for capital. There we have seen the capital base growing, obviously on the back of earnings.
Bit of a reduction in the loan book this quarter, but also we have been focusing on our REAs and the optimization project on that front, and they're seeing some benefits from there. So at this moment, we are now at 20.9% CET1 capital. Currently, our sweet spot in terms of CET1 is 17.2%, and that will grow to 17.7% once the countercyclical buffer goes up by 50 basis points early next year. And that means that we have around 300 basis points of excess CET1 capital excess in excess of our sweet spot.
But overall, the excess of CET1 is 580 basis points, based on the regulatory requirements as they stand today. So extremely strong capital position and gives us the opportunity, obviously, either to return some of that to shareholders or to see additional growth in the next few years. So back over to you, Bjarney, in terms of the Q&A.
Yes, now we open up for a 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 using the webcast form. Operator, are there any questions on the line?
If you wish to ask a question, please dial star five on your telephone keypad to enter the queue. If you wish to withdraw your question, please dial star five again on your telephone keypad. The next question comes from Sofie Peterzens from JP Morgan. Please go ahead.
Yeah, hi. Here is Sofie from J.P. Morgan. So maybe just to ask a question on your last comment. So you have plenty of excess capital, even if you adjust your kind of capital buffer for a higher countercyclical, you're well above 500 basis points. I saw that you started the ISK 5 billion share buyback. Now, how should we think about kind of shareholder remuneration going forward? Because at the current level, you are accumulating quite a lot of capital. So maybe if you could just talk a little bit about that. And then how should we think about wage inflation in 2024? Kind of where is the kind of wage growth settling, and what have you agreed with the staff?
Then final question would be on the net interest income outlook. Net interest income was a bit weak, but it seems that it was a little bit driven by... I don't know if they are one-offs, but maybe you could just talk about the sustainability of the items that had a negative impact on NII in the quarter, and how we should think about these factors going forward. Thank you.
Okay. Thank you, Sophie. First, in terms of the capital, the buybacks, so we have now started on that program. We, based on the turnover in the market, can buy back around ISK 1 billion per month. And, so we have now made the first step of ISK 1 billion, and then obviously, we'll just assess how the market is on the back of that. And, but the plan is to go, to continue and then finalize the ISK 5 billion program. And, we will see how far we can get before our annual general meeting next year, and then obviously, we will ask our meeting for further opportunities there.
As we have stated, we plan to optimize the capital structure before the end of next year. So again, subject obviously to market conditions. And so that's what we're looking into. In terms of wage inflation, that's actually quite difficult to tell. These general wage agreements are now starting, and it's very difficult for me to predict what will be the outcome there.
The our chief economist, I think, has been expecting somewhere around 7%-8%, but again, it's a very difficult question also, how it will be for different unions and the different, basically, different industries, because it's in the past, we have had actually fixed salary increases, fixed number rather than percentages. Now, the big question is whether that will be again going forward. So it's a bit tricky for me to say exactly how that will pan out. In terms of net interest income, as I mentioned, we expect to be running at around 3%, somewhere in that range, you know, 2.8%-3.2%, probably.
The factors that I mentioned, the reduction from the second to the third quarter, the FX costs, those will obviously continue, and then we'll see in the quarters ahead, you know, how our funding costs there will develop, and they obviously have moderated quite substantially during the third quarter, based on the secondary trading in the markets. Then it's the inflation part, and that obviously depends on both the rates, the nominal rates, the real rates and the inflation. So that's something that can move a bit around between quarters.
But we have...f irstly, we are long inflation, and it's mostly on floating rates or adjustable rates, which we can adjust basically based on the environment, which obviously reduces our risk there quite substantially. So, I think that's the best indication I can give, you know, around 3% plus, minus a couple of percentage points in terms of the margin.
Thank you. And what about the loan growth? How should we think about loan growth going forward?
Yeah. So, in terms of loan growth, we expect, you know, so through the cycle, we expect to grow with nominal GDP. Nominal GDP growth in Iceland over the longer term is expected to be around 5%-6%. Then it's also a question, you know, within certain periods. Now, it's obviously running at high rates. The central bank is trying to cool down the market, so I would expect to see a lower growth in the coming few months, on the back of that. And then it's a question of, in terms of the mortgages, how the competition environment will be there. A lot of customers moving to inflation linked.
So we do expect to see some market share moving over to the pension funds on that front. So I would think that we will see, you know, rather moderate loan growth in the near term, but over the longer term to grow in line with nominal GDP.
Thank you. That's very clear.
Mm-hmm.
Are there any additional questions from the platform?
If you wish to ask a question, please dial star five on your telephone keypad to enter the queue. If you wish to withdraw your question, please dial star five again on your telephone keypad. There are no more questions at this time, so I hand the conference back to the speakers for any closing comments.
Thank you. We have here, questions on the platform. [Kian Abouhossein ] from JP Morgan asks, "Is there any update on talks with Kvika? Have you resumed the discussions, or is it completely dropped for now?
Okay. Yes, so that was quite clear in the summer, that those discussions were basically aborted, and there have not been any indications or any discussions since then.
And for a final question. No, we're adding more. From Namita Samtani, from Barclays, on net interest income: "Do you see customers shift to higher-yielding saving products? Could you explain what type of customer behavior you are seeing on the deposit side, and also on the lending side?
Mm-hmm. Okay, so on the deposit side, yes, we are seeing some shift to higher-yielding products. Customers are becoming quite aware, and obviously, it's quite easy to move between deposit accounts. So we are definitely seeing some shift there, and we expect that there will be a trend going forward as well. On the lending side, like I said, the main trend is especially on the market side, borrowers moving into inflation-linked. We see a bit of that on the corporate side, but much less so. Some of our corporates have, for example, rental agreements, where they have revenue in which is inflation-linked, so it's a natural hedge for them to move into that kind of a borrowing.
So that's, I would say, the main trends at the moment.
Okay, and, a question from Ileana Kolu. Two questions, actually. One, on asset quality: "Could you please comment on the one exposure which drove the higher impairments this quarter?
Mm-hmm.
You can comment on industry or whether it was an idiosyncratic one." And the second on capital optimization: "You mentioned further capital optimization. Could you consider an AT1?
Mm-hmm. Yeah, so in terms of the asset quality, obviously, I can't comment on the borrower, but I can say that it's a very idiosyncratic, so it's not a... It was a very specific case, so it does not indicate a trend in a specific sector. It was a very specific case. In terms of the capital optimization, we will certainly look into the AT1 market. That obviously had a very difficult times, that market, in the first half of this year, but has been strengthening again, and we will be looking into that in the coming year or so, to see if we find opportunities there.
Thank you. As I see no further questions, I want to thank you for joining us this morning. We appreciate all the questions and the time you have committed to join our webcast this Friday morning.
Thank you.