Funding and liquidity

In October Standard & Poor’s upgraded Arion Bank’s credit rating from BBB- to BBB with a positive outlook. Improving access to international credit markets means the Bank is continuing to diversify its funding. Arion Bank issued two benchmark transactions in 2016. In April Arion Bank issued bonds for a total of €300 million. In December the Bank issued bonds in euros amounting to €300 million. The issue was tapped for a further €200 million at the beginning of 2017, bringing the total issue to €500 million. It was the largest and longest issue by an Icelandic bank in recent years and represented a landmark for Icelandic banks in terms of their access to the international capital markets.

Funding

The Bank’s main source of funding is customer deposits. Over the past few years the Bank has taken significant steps to diversify its funding, with measures including issuing bonds in euros and other currencies. On the Icelandic market the Bank has continued to issue covered bonds and commercial paper.

EMTN issues

At the beginning of 2016 the Bank concluded a funding agreement with Kaupthing. Under the agreement Arion Bank issued a bond in the amount of $747.8 million. The bond is a 7-year instrument and is callable on due interest dates for the first two years. The bonds bear floating LIBOR + 2.6% margin in the first two years and after that the interest margin will be based on market rates. The bond offset loans in foreign currency originally taken by the Bank from the Central Bank of Iceland and now owned by Kaupthing, and Kaupthing deposits in foreign currency at Arion Bank. The issue was part of the package of measures involving Kaupthing which were aimed at the lifting of the capital controls and were announced by the government on 8 June 2015. Arion Bank made two prepayments of total $490 million in 2016, bringing the outstanding amount of the bond to $258 million at year end 2016.

In April Arion Bank issued bonds for a total of €300 million. It was the Bank’s second issue in euros to a diverse group of investors. Offers were received from approximately 70 investors for more than €500 million. The bonds are 3-year instruments and bear a fixed 2.5% coupon and were sold at terms equivalent to 2.70% margin over interbank rates.

In December Arion Bank issued 5-year bonds for a total of €300 million. Offers were received from approximately 50 investors for more than €400 million. The instruments bear a fixed 1.625% coupon and were sold at terms equivalent to 1.65% margin over interbank rates. At the beginning of 2017 the issue was tapped for a further €200 million at terms equivalent to 1.55% margin over interbank rates, bringing the total issue to €500 million.

The Bank also completed smaller private placements in NOK, SEK and other currencies during the year. The total amount of EMTN private placements equaled ISK 13.8 billion.

During the year Arion Bank prepaid the remaining ISK 10 billion subordinated loan from the Icelandic treasury. The Bank used some of the proceeds from the Bank’s bond issues in foreign currencies to pay off these loans. By paying off these loans the Bank considerably reduced its interest expenses as the subordinated loans bore floating LIBOR/EURIBOR rates +5% at the beginning of 2015.

Credit rating upgraded

Standard & Poor’s (S&P) upgraded Arion Bank’s credit rating from BBB- to BBB with a positive outlook. The upgrade reflects the improving conditions in the Icelandic economy, the deleveraging of Icelandic households and corporations and the positive impact of the continued liberalization of capital controls. S&P also took into account Arion Bank’s improved access to international funding markets and the improved capital structure following the sale of legacy equity positions.

S&P Credit rating of Arion Bank and Iceland

*Foreign currency obligations. Please visit www.cb.is for further information.

Issues of covered bonds and commercial paper

Arion Bank continued to issue covered bonds which are secured in accordance with the Covered Bond Act No. 11/2008. The Bank issued covered bonds amounting to ISK 24,840 million in 2016. In December the Bank issued a new fixed rate series, ARION CB 19.

Arion Bank renewed its agreement with Kvika, Íslandsbanki and Landsbankinn on market making for covered bonds issued by Arion Bank on Nasdaq Iceland. The purpose of the agreement is to stimulate trading with benchmark covered bonds issued by the Bank.

The Bank has continued to issue commercial paper in the domestic market and this has further diversified the Bank’s funding. The Bank sold commercial paper for a total of ISK 23,460 million in 2016, the outstanding amount at year end was ISK 13,854 million.

Liquidity and liquidity risk

Arion Bank is partly funded with deposits from individuals, corporations and pension funds. One of Arion Bank's key objectives is to maintain a strong liquidity coverage ratio (LCR) which is calculated according to rules issued by the Central Bank of Iceland. LCR builds on European liquidity regulations based on the Basel III standard and addresses risk factors relating to the stickiness of deposits and the maturity mismatch of assets and liabilities. At the end of 2016 the Bank's LCR was 171% and the ratio for foreign currencies was 263%, well above the minimum requirement stipulated by the Central Bank of Iceland.

Uncertainty over the lifting of the capital controls has largely been eliminated. Following the fulfilment of stability agreements last year, liquid deposits of non-residents and financial institutions constitute a very insignificant part of the Bank's funding. The Bank’s liquid assets at the end of 2016 totalled ISK 182,712 million, or 18% of total assets.

The Bank’s net stable funding ratio, NSFR, was 124% at the end of 2016 and 191% in foreign currency. This ratio measures the proportion of Bank’s available stable funding to necessary stable funding according to a method which takes into account the liquidity of assets and the maturity of liabilities. These ratios indicate that the Bank has stable funding.