Adjusted earnings of Arion Bank amounted to ISK 9,737 million in 2016. Net interest income and net commission income are relatively stable but income from shareholdings and bonds tends to fluctuate. There was a considerable year-on-year increase in operating expenses, which was mainly related to higher salaries under new wage agreements. In respect of adjusted operations Arion Bank makes adjustments for capital gains and valuation changes in acquired equity positions, the effect of subsidiaries engaged in unrelated operations, a one-off expense due to redundancies and professional services, and valuation changes in loans. Taking the above factors into account, net earnings in 2016 decreased by ISK 12,002 million to ISK 9,737 million. Return on equity from adjusted operations was 4.7%, compared with 8.7% in 2015. The cost-to-income ratio for adjusted operations was 58.3%, compared with 54.1% in 2015.
Operating income amounted to ISK 53.4 billion, compared with ISK 86.2 billion in 2015. The main changes between years are in net financial income and the share of profit of associates which were significant in 2015 due to valuation changes and earnings from the sale of shareholdings in connection with the stock market listing and sale of the companies.
Net interest income increased by 11% from the previous year. The net interest margin as a percentage of average interest-bearing assets was 3.1% in 2016, compared with 3.0% in 2015. The growth of net interest income is mainly due to an increase in interest-bearing assets, i.e. new lending and cash for equity positions.
Net commission income decreased by 3% between years, primarily as a result of an exceptionally high level of activity in investment banking in 2015 following a number of IPOs and a difficult environment in the foreign operations of card and payment solutions at the subsidiary Valitor. Approximately 80% of net commission income originates from corporate clients. Valitor has greatly expanded its business in the Nordic countries and the United Kingdom. The company is experiencing rapid growth but the positive impact on net commission income will not materialize until the next few financial periods, as is generally the case with growth companies. There was an increase in commission income in retail banking from the previous year, partly due to the opening of a branch at Keflavík International Airport in early 2016.
Net financial income amounted to ISK 5,162 million, compared with ISK 12,844 million for 2015. Realized gain on the sale of Valitor’s shareholding in Visa Europe Ltd. to Visa Inc. amounted to ISK 5,291 million in the second quarter of 2016. Net financial income from other financial assets was satisfactory during the second half and partly offsets the loss generated in the first half of 2016 due to challenging market conditions, particularly on equities. Dividend income amounted to ISK 2,280 million, compared with ISK 7,954 million for 2015. The appreciation of the Icelandic króna resulted in a foreign exchange loss of ISK 1,253 million in 2016, particularly by subsidiaries.
Net insurance income amounted to ISK 1,395 million, compared with ISK 760 million for 2015. The increase is because of the acquisition of the insurance company Vördur at the end of September 2016.
Share of profit of associates amounted to ISK 908 million, compared with ISK 29,466 million in 2015. Last year this item was heavily influenced by valuation changes and the sale of shareholdings in connection with the stock market listing of companies in 2015, whereas the main factor this year is the profit from sale of a shareholding in Bakkavor Group Ltd. in the first quarter of 2016.
Other operating income increased by ISK 472 million from the previous year and amounted to ISK 2,096 million in 2016. The increase is mainly related to profits from the sale of assets during the period.
Operating expenses amounted to ISK 30,540 million, compared with ISK 27,811 million in 2015. The Bank’s cost-to-income ratio was 57.2%, compared with 32.3% in 2015. This substantial increase in the cost-to-income ratio is mostly attributable to high income from valuation changes in equities and profits from the sale of assets in 2015. The cost-to-assets ratio was 3.0%, compared with 2.9% in 2015.
Salaries and related expenses amounted to ISK 16,659 million in 2016, an increase of 12% from the previous year. The increase is mainly a result of renewed wage agreements, a rise in the number of employees, partly related to acquisition of Vördur, as well as expenses in relation to the redundancy of 46 employees at the end of September. The average salary per employee increased by 7.1% from 2015, but at the same time the salary index rose by 11.3%. Full-time equivalent positions at the end of year totalled 1,239 at the Group, 92 more than at the end of 2015. The increase is largely a result of investments in new business opportunities in Iceland and abroad. Most significant in this respect are the acquisition of the insurance company Vördur, the growth of Valitor internationally and the opening of a new branch at Keflavik International Airport.
Net valuation change
Net valuation change was positive by ISK 7,236 million in 2016. The positive net impairment is in particular due to the revaluation of acquired mortgages in the third quarter.
Income tax amounted to ISK 6,410 million, compared with ISK 3,135 million in 2015. Income tax, as reported in the annual financial statements, comprises 20% income tax on earnings and a special 6% financial tax on the earnings of financial undertakings in excess of ISK 1 billion. The effective income tax rate was 23.5%, compared with 6.0% in 2015. The unusually low effective income tax rate in 2015 is mainly explained by tax exempt earnings at corporates relating to valuation changes and profits on equity positions. Total taxes paid by financial undertakings remain higher than those paid by other companies operating in Iceland. Taxes paid specifically by the Bank as a financial institution amount to ISK 5.0 billion.
Bank Levy and other taxes. In addition to income tax Banks in Iceland pay three special taxes. Bank levy is 0.376% of total debt over ISK 50 billion and amounted to ISK 2,872 million, compared with ISK 2,818 million in 2015. Additional income tax is 6% on taxable income over ISK 1 billion and amounted to ISK 1,395 million, compared to ISK 628 million during 2015. Tax on salaries which is 5.5% on employee salaries and salaries amounted to ISK 776 million, compared to ISK 689 million during 2015.
Balance sheetArion Bank’s total assets increased by 2% from the previous year. The main changes result from increases in balances with the Central Bank and loans to customers. Loans to credit institutions, investments in associates and financial assets decreased, however.
Loans to customers
Loans to customers totalled ISK 712,422 million at the end of 2016, a 5% increase from year-end 2015. Loans to corporates increased by 5%, or ISK 19 billion, during the year. These new loans are mainly in real estate activities and industry, energy and manufacturing. Mortgage loans to individuals increased by 5% in 2016. The quality of loans to customers continues to improve. The ratio of problem loans decreased from 2.5% to 1.6% during the year. The Bank defines problem loans as the ratio of the book value of loans 90 days or more in default and loans for which special impairment is required to the Bank’s total loans to customers. The proportion of impaired loans decreased from 4.7% at the end of 2015 to 3.2% at the end of 2016.
The loan portfolio of the Bank is well diversified, the split between loans to individuals and loans to corporates is almost even. Loans to corporates diversify across sectors in line with the Icelandic economy.
Financial assets amounted to ISK 117,456 million at the end of 2016, compared with ISK 133,191 million at the end of 2015. Financial assets decreased due to the sale of assets, including the sale of holdings in Visa Europe Ltd. as well as due to a decrease in market value. Changes in financial assets are also related to liquidity management.
Investment in associates
Investment in associates decreased significantly from year-end 2015, mainly due to the sale of shareholdings in Bakkavor Group Ltd. in January 2016. Current investments in associates are almost solely related to the core business of the Bank, in particular in information technology.
Liabilities and equity
Liabilities increased between years, which is primarily a result of new borrowings. Equity increased as a result of the financial results in 2016. Non-controlling interest decreased due to the disbursement of share capital and dividend payment of the subsidiary BG12 (owner of shareholding in Bakkavor Group Ltd.) and due to the sale of a large shareholding in the subsidiary Kolufell in 2016.
DepositsTotal deposits amounted to ISK 420,051 million at the end of 2016 which is a slight decrease from 2015 when they amounted to ISK 480,734 million at year end.
Borrowings amounted to ISK 339,476 million at the end of the year. In January 2016 the Bank reached an agreement with Kaupthing regarding FX deposits held at Arion Bank to be converted into an issued EMTN bond in US dollars and that Kaupthing would prepay Arion Bank's Central Bank secured loan, in various currencies, of ISK 56 billion at year-end 2015. The total issue was ISK 97 billion ($747 million) with mandatory prepayment requirement if the Bank should issue bonds in excess of $165 million. In 2016 Arion Bank's issue exceeded this benchmark twice and therefore prepayments of ISK 57 billion ($490 million) were made in 2016. At year-end outstanding bonds held by Kaupthing amounted to ISK 29.3 billion ($258 million).
The Bank issued a new 3-year €300 million bond in April and 5-year €300 million bond in November, which have been trading favourably on the market as other bonds issued by Arion Bank. The Bank has also continued to issue covered bonds in the Icelandic market, a total of ISK 24.8 billion during the year.
Subordinated loans were paid up at the end of third quarter. Approximately 2/3 of the loan had been prepaid in 2015 and the remaining part was paid up in 2016 following a successful issue of bonds in the international market during the year.
Shareholders’ equity amounted to ISK 211,212 million at the end of 2016, compared with ISK 192,786 million at the end of 2015. The increase is explained by the financial results for the year. The Tier 1 ratio was 26.5% at the end of 2016, compared with 23.4% at the end of 2015. No dividends were paid during 2016. The Board of Directors proposes that net earnings be added to equity and that no dividend be paid in 2017 for the fiscal year 2016, for now. The Board of Directors has a broad authority to suggest that the Bank pay dividends or other disbursement of equity and may convene a special shareholders' meeting later in the year to propose a payment.