Good morning, and welcome to this webcast, presentation of Íslandsbanki Third Quarter Result. I'm Birna Einarsdóttir. I'm the CEO of Íslandsbanki, and with me here today to present is J ó hann Wathne, Head of Treasury. Yes, Jón Guðni, our CFO, is not with me here today. He's doing a executive course in, program in Harvard, and will be coming next week, back next week stronger than ever, I hope. Thank you for taking the time to join us this morning. We, actually, we were encouraged to be in a Halloween outfit for this presentation, but I said that I am hopefully scary enough. We published our result yesterday.
We are very happy with the result and the outcome, and I'm looking forward to take you through the highlights and then Jóhann will take you through all the details in the financials. Like before, following the presentation, we will have a Q&A session. You can participate in the session via the conference call using the dial-in details, and the operator will give you the floor, or you can submit questions in writing using the webcast form. Moving over to the highlights, we are presenting here today a very strong result for the third quarter. Over 14% return on equity, which is above our target and above the consensus, the analyst consensus. Very happy with the result.
On the income side, we saw 21% growth year - on -year, and the main driver being increase in the interest rate income, nearly 30%, and we also saw a growth in the fee and commission income. Where is it coming from? Yes, investment banking, card fee, and other income. Our cost target for this year has been very challenging. We said that the target was to have the same cost as we had last year, and when we are operating in up to 10% inflation, that has been a challenge. I'm very proud to see that we have managed to do so for the first nine months.
The cost-income ratio for the third quarter is 36%, just over 36%, lower than our target and something that, as I say, we are very proud of. Of course, the positive impairments of ISK 1.1 billion is helping us with this result. Why do we have positive impairments? It is because of the tourist industry. The outlook is more positive, and there is an updated real estate valuation, and we have also been closing a distressed credit case in a favorable way. During our last presentation, we said that we had around ISK 1 billion COVID impairment left. In the third quarter, we have kind of removed the COVID factor in full.
The asset quality of the loan portfolio remains strong, and the loan book is very well diversified and very well collateralized. In the light of the good financial result for the remainder of the year, we have revised the 2022 targets and guidance for return on equity, that we are saying now will be between 11% and 13%, but previously we said 10%, over 10%. We are also revising the guidance for cost-income ratio, now saying it will be between 41%-44%, and previously we said 44%-47%. On the next slide, we will have a quick look at the Icelandic economy. It has recovered well, and we have seen a rapid growth both in consumption and investment and a steady growth on the export side.
Our chief economist is expecting an economic growth over 7% this year, and we see that tourism and exports is taking over by the domestic demand as the main driver of growth. The tourist sector has been enjoying a very strong recovery, and the number of tourists in the high season were similar to the year 2019. The economy has also proven more resilient than the European peers and to impact from the war. The domestic renewable energy supplies most households' energy needs, which of course help in the circumstances. Inflation peaked at just under 10%, is now around 9.4%, and is going down, hopefully. The central bank has indicated an end to its rate hikes, and we now have a policy rate currently 5.75%.
I'm sure that most of us think that is enough. This slide is giving you an overview of our business units and the performance in the third quarter. All the business units did very well. The personal banking had a successful quarter, and they launched a new digital account called Ávaxtun. That has been a great success. We launched first in Iceland, a Google Wallet, and now you can trade securities with our app, and we have seen a great up-take there. Business Banking with a very high return - on - equity, record one, strong growth on the loan side, and Corporate & Investment Banking, growth on all fronts. We, for example, have seen a record months lately in, for example, if we take one example, in the FX brokerage.
Íslandssjóðir has also had a good quarter despite, of course, some very difficult markets. On the sustainability front, I will tell you a little bit about that later. One thing I would like to mention especially on the business side, at the end of the third quarter, the sale of Míla, the key telecom infrastructure company in Iceland, was completed. This sale is one of the largest M&A transactions since 2008. Íslandsbanki did play a big role in this sales process, and the case is a good example of the bank's ability to provide the full scale investment banking service needed to successfully carry out such a milestone transaction. Very happy with the result here. Last year, we did set out a very bold goal.
We said that we were going to be net- zero emission by the year 2040. Together with the result yesterday, we did publish our report, and we are the only Icelandic founding member of the industry-led Net-Zero Banking Alliance. It is an important step on this journey. We now published our sector-specific emission reduction targets, covering over 60% of our lending, and 71% of our total emissions. We have also published our financed emission estimates for 2021, but the main thing is that we are projecting to fall by 60% for our balance sheet by the year 2030 and down to 85% 2040.
The largest gap is aviation and maritime shipping, but our customers in those sectors have a very ambitious goals, so we are sure that we will be there in the year 2040. Very proud of where we are, but a lot of work ahead of us. Now over to you, J ó hann .
Thank you, Birna. Good morning to you all, and happy Friday. I think we just should dive into the numbers, and as Birna said, we are very pleased with the outcome of the third quarter. Here we are showing a bridge comparing the profit for this quarter to last year. As can be seen here, the increase in net interest income is the fundamental driver for the robust results. However, we're seeing a decrease in the net financial income, and we're also seeing a slight increase in impairments and income tax. I will go into these items in the coming slides. Birna meant, so we are...
Net interest income, Birna said we had a very impressive growth here, almost 29%, which can be explained by volume growth, where we're seeing a good increase in our loan book and also in our deposit base, but we are also benefiting from the higher rate environment. Net interest margin is growing and is currently at 3%. Lending margins are decreasing slightly, but deposit margins are increasing and therefore driving the growth in NIM. The Central Bank of Iceland has been very aggressive hiking rates this year. We've seen an increase in the base rate from 2% to the current 5.75%, and our economists are hopeful that we are at the end of the tightening phase.
When it comes to the fee and commission income, we saw a good growth there during the quarter. The main driver here is cards and payment processing due to increased card activity. We were also very pleased with the outcome of our investment banking unit during the quarter. Despite a slight decrease in fees, they had a very good quarter. Birna mentioned the Míla transaction earlier, but we had a good quarter in the FX brokerage unit, which is benefiting from the strong export sector during the summer months. It's worth noting that the fees from the bank's IPO that took place last summer were booked in the third quarter last year.
Assets under management at our Íslandssjóðir unit or subsidiary were stable between quarters and fees from asset management are therefore flat between years. When it comes to net financial income, it's good to have a very conservative strategy when it comes to market risk in these turbulent times. You can see that our exposure to shares and equity instruments is limited as before. We're seeing growth in bonds and debt instruments, and that is the reason there is a rise in our liquidity book. We have a very secure portfolio. The reason for the loss in this item is a movement in the ISK base rate curve during the period. When it comes to costs, we're very pleased with where we are.
Cost is relatively flat to last year. There is a seasonality in the numbers, mainly in salary expenses, and that is the main reduction between quarters, so from the second quarter this year. Birna mentioned that we are updating the 2022 guidance for the cost-income ratio. We are now estimating that the cost ratio will be in the range of 41%-44% from the previous 44%-47%. We assume that the cost number will be relatively flat this year. When it comes to guidance for 2023, for the absolute cost, we had previously stated that the cost will be flat to this year. However, it's worth highlighting that the inflation is higher than when we set that target.
Also, it's produced some uncertainty that there are four collective salary agreements taking place this autumn. Moving on to asset quality and impairments. We continue to reverse impairments, and we are releasing ISK 1.2 billion this quarter. Most of that is due to more positive outlook in the Icelandic tourism industry and updated official evaluation for real estate. Economic scenarios are, however, negatively affected by increased inflation. During the last six quarters, we have released about ISK 6 billion of impairments. The annualized cost of risk for the quarter was 40 basis points and 26 basis points when you look at the first nine months of the year. One can see from the graph there, bottom, top right, that loans in stages two and three continue its positive trajectory.
Onto loans to customers. We're seeing loans to customers being stable from the last quarter, but they have increased by 6.1% during the year. As before, the loan book is collateralized with very solid underlying collateral. You can see that from the graph there, bottom left, that real estate is the single largest collateral. The average LTV for the underlying collateral has decreased this year from 61% to the current 58% as a result of updated official real estate tax value. One can see that loans to individuals, graph top right, that loans to individuals are now almost 50% of the bank's loan book. Moving on to the mortgage book.
That portfolio has increased by roughly 10% during the year, but the vast majority of the growth this quarter is a result of an increase in inflation. The credit quality of the mortgage book remains strong, with 1.5% of the loan book either in stage two or stage three loans. As for the overall portfolio, the LTV for the book has been decreasing, which is again explained by the updated tax valuation. The households in general are overall in a very good position. Nominal wages have increased, and unemployment rate in Iceland is low. When it comes to real estate and the construction sector exposure, we have around 10% of the bank's loan book in real estate and less than 5% in construction.
We have the split of the real estate portfolio here on bottom right, and that exposure is very well diversified by collateral. Around 50% of the construction portfolio is for residential, building residential apartments, 20% for commercial real estate, and the rest is mixed. The asset quality of this portfolio is solid, as can be seen in the graph bottom left. Moving on to funding. Deposits, as before, are the largest source of funding, and we're seeing a growth in deposits this quarter of 3.3%, mainly coming from individuals and SMEs. As loans to customers were unchanged between quarters, the customer deposit to loan ratio decreased to 148% at period end.
Birna mentioned earlier the new fully digital account Ávaxtun, which offers one of the best rates in the Icelandic market, and that has been a great success with our retail customers. When it comes to market-based funding, we are continuing with our journey of diversifying our sources, and we made a good stride towards that during the quarter. We issued our inaugural COVID bond in euros in September, which was very well received amongst international investors. The bond was rated A by S&P. In October, we issued our inaugural Tier 2 transaction in ISK, which was sold to domestic accounts of ISK 10.5 billion. This week, we announced that we will be calling the outstanding SEK 750 Tier 2 bond that is up for a call now in November.
Liquidity is very solid. All ratios are above internal and external requirements. Just wanted to point out that liquid assets, graph bottom left, liquid assets are now 20% of the bank's total assets. Lastly, on capital. The countercyclical buffer in Iceland was increased in September from 0% to 2%, and that raised the bank's overall capital requirement from 17.9% to 19.9%. The capital ratio decreased marginally, but that is a result of increase in REA, and the increase in REA is a result of increase in the bank's liquidity portfolio. The total capital ratio includes unaudited net earnings for the third quarter, with a deduction of 50% of net earnings as foreseeable dividends according to the dividend policy, and also a foreseeable buyback of ISK 15 billion.
The CET1 ratio remained at 18.2%, which is 300 basis points above the requirement. That is considerably above the bank's long-term target of 16, or approximately 16.5%. We have stated in previous quarters our intentions to explore share buybacks and potential release of capital through dividends. As everyone is much aware of, the capital markets have been extremely volatile over the past few months, and the capital distribution is therefore subject to more stable market conditions. Also, in the light of global economic uncertainty, the Central Bank of Iceland has asked the Icelandic banks to be careful in terms of capital distribution in the near term. Finally, a few points on MREL. BRRD1 has been implemented into Icelandic law.
The MREL requirement of the bank is 2x Pillar 1 plus Pillar 2, which is roughly 21.2% of the total risk exposure amount. The bank's MREL ratio at the end of September was 27.6%. The subordination requirement provided for in BRRD 2 has not been defined. Now we open up for the Q&A session.
Yeah.
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. Operator, are there any questions at this time?
Thank you, dear speaker. Dear participants, as a reminder, if you wish to ask a question over the phone, please press star *11 on your telephone keypad. Now we're going to take our first question over the phone. Please stand by. The first question comes from the line of Sofie Peterzens from JP Morgan. Your line is open. Please ask your question.
Yeah. Hi. Here is Sofie from JP Morgan. I had two questions, please. My first question is on the impairments. You saw a quite large level of write-backs in the third quarter. How should we think about further write-backs kind of in coming quarters and in 2023? The second question would be on capital distribution. Clearly, as you note in your presentation that the Icelandic or Iceland or the government basically wants you to maybe be more prudent with capital distributions going forward.
Could you just give an update on the share buyback and how we should think about the ISK 15 billion share buyback, will it be on hold or should we expect that to come through? Thank you.
Thank you very much, Sofie. The impairments, as you see from the accounts that we had, positive impairments for the last quarter, and there is a different reason, as we mentioned in our presentation. The biggest one being the real estate revaluation, you know, official one. It was in a way also on the negative point because of increased inflation that also impact the third quarter. For the year 2023, I think we are going to see more normal impairment. We have said that we expect our cost of risk to be around 30 points. That is what we are expecting.
We also mentioned that the impairment that we did put aside for COVID. We have kind of released what we had there. I think we are moving to more normal times.
When it comes to capital distribution, Sofie, we will use this quarter, the Q4 to explore our options there. We just need to be mindful of what's happening out there in the capital markets. We are a conservative institution, we will continue to do so.
as you're always saying, we will start working on this next steps seeing how the market condition is and start the talk with our board and so on about the next steps and hopefully be able to inform about that soon. Is that-
Okay. No decision has been made yet on the capital distribution?
No.
Okay.
Okay. Thank you.
Thank you very much, Sofie.[Crosstalk]
Thank you, Sofie.
Thank you. Dear participants, as a reminder, if you wish to ask a question, please press *11 on your telephone keypad. Dear speakers, there are no further questions at this time, oh, please accept my apologies, just one line came through. Are you happy to take?
Yes.
Yeah.
Thank you very much. Now we're going to take the next question. Please stand by.
Can you hear me?
The next question comes from the line of Piers Brown from HSBC. Your line is open. Please ask your question.
Yes. Good morning. I just had a question on the NFI result, which is obviously negative this quarter. I'm just sort of struggling to get my head around the drivers of NFI because, I mean, in my sort of simple understanding of this, you have a large book of fixed floating swaps, and I think that was what gave you the big revaluation positive in the second quarter. Just given that we've had further short-end interest rate increases in the third quarter, I sort of anticipated you'd have further revaluation on that book. But actually looks like you had a negative result on the other derivative line. Just if you could shed any light on what the moving parts, the mechanics are.
Yeah.
Of that number, that'd be very helpful.
We could also take that offline, Piers. Without going into too much detail, the main reason for the loss in this line item is a movement in the ISK-based rate curve. We have few currency swaps which moved against us this quarter. That is the main reason for the drop in this quarter, but we can take that offline if you want to.
Yeah. Okay. No, that's very helpful. It's a bit of a different book-
Yes.
-that gave the-[Crosstalk]
Yeah.
The loss this quarter relative to what produced the gain last quarter.
That is correct.
Okay, that's very helpful. Yeah. Just on the, just one follow-up maybe on the real estate revaluation.
The impairment release related to that. Can you just, I mean, I'm a little bit unfamiliar about that type of situation. I haven't really seen it with other banks. Can you just give a little bit more explanation as to what exactly has been going on there or what exactly the change was that you implemented?
Yeah. Now we are taking into account the official tax value of real estate, which is published every year, sort of in August. That is taking into account in the impairment process and also decreases the LTV of the overall book. This is an official valuation that is published officially in Iceland. We're taking that into the numbers now.
Do you not do your own valuations of property when you grant a loan?
Yeah. We, I mean, of course, we are doing that, but this is the official one and we're using that in our models.
The main impact is, of course, for the mortgages where we use this valuation only.
Okay. For the residential mortgage book?
Yeah.
Okay.
A big part of our loan book.
Okay. How frequently do the tax valuations get measured, get adjusted?
How often?
Once.
It's once a year.
Once a year, yeah.
Published in
Once a year.
Published in August.
Okay.
It's based on basically Q1 numbers, but published in August or in the autumn every year.
Okay. That's very clear. No, thank you. Thanks for the clarification.
Thank you very much.
Thank you, Piers.
Thank you. Dear speakers, there are no further questions over the phone at this time. Please continue.
No questions? No.
Okay. If there are no further questions, are there any questions in writing? Brilliant. Okay. On the final notes, as I mentioned before, we are very happy with the result, and we will continue to work hard to deliver despite the difficult market condition. I just wish you a very good weekend. Thank you very much.
Thank you.