Roundtable: Fast-growing Iceland looks forward
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Roundtable: Fast-growing Iceland looks forward

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What is the future for Iceland’s capital markets and economy? GlobalCapital convened a group of bankers in Reykjavik in May to discuss key themes, including inflation, the banking industry, green energy and the impact of recent volcanic activity

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Toby Fildes, GlobalCapital: Let’s start with inflation. How is Iceland’s Central Bank’s fight against inflation going?

Hreiðar Bjarnason, Landsbankinn: It’s improving. Inflation is still somewhat elevated at around 6% and the Central Bank of Iceland is dealing with high inflation expectations going forward. So it seems the Central Bank wants or needs to have real interest rates much higher than you would expect in western countries. So they seem to be looking at 3% real interest rates, which is obviously significantly higher than you would want to be needed to cool down the economy. So that’s the big challenge that the Central Bank is facing.

Ólafur Hrafn Höskuldsson, Arion: It’s good to see that in the last decision we saw that most of the drivers of inflation are moving in the right direction and inflation is down to 6% from the highs of 10s at the end of last year. One of the challenges is the real estate driver and that goes into what Hreiðar was saying. The economy is growing fast. We had a huge population growth over the past couple of years.

The housing market maybe hasn’t caught up and then, on top of that, 1% of the population, due to the volcanic activity near Grindavík resulted in people needing to evacuate their homes and reallocate. So this is the key challenge now.

Ellert Hlöðversson, Íslandsbanki: I agree. If you look at the composition of inflation, domestically versus internationally, internationally it tended to go hand in hand with energy prices. Obviously, that’s not the case here, where the housing market has been driving inflation. Unfortunately the Central Bank discovered that GDP was being under-reported over the last two years which eventually led to a revision — the consequence of that was that monetary policy had been if anything too lax in hindsight. That doesn’t help. So we have high interest rates but we haven’t been looking at correct figures in controlling monetary policy as well.

Fildes, GC: The Central Bank is not alone in underestimating inflation. We’ve seen it in a lot of places in the world, with maybe the exception of Saudi Arabia.

Apart from the housing market, one of the biggest uncertainties at the beginning of the year was the collective union wage negotiations. That’s at least partly now out of the way with long-term agreements, which is a big step
Ólafur Hrafn Höskuldsson, Arion Bank

Friedrich Luithlen, DZ Bank: But you had real estate included in the inflation numbers.

Hlöðversson, Íslandsbanki: That was not actually the difference in the measurement. The difference was primarily in investment and it had to do with new sectors domestically, which the stats of Iceland don’t have any good data points to get into. So, they were underestimating investments into corporates, more or less.

Höskuldsson, Arion: All that means is that we are probably going to see these rates till the autumn at least. People were hoping to get the first drop in May but that’s not going to happen so it’s most likely it’s going to occur in the autumn. But the good thing, apart from the housing market, one of the biggest uncertainties at the beginning of the year was the collective union wage negotiations. That’s at least partly now out of the way with long-term agreements, which is a big step. And hopefully the other unions are now following one by one.

Fildes, GC: I mentioned that many countries have had inflation shock, I wonder if the causes of Iceland’s inflation were perhaps different from other countries? You mentioned, Fritz, real estate being part of the bucket. Was there anything special about Iceland’s inflation, and is it under control now?

Bjarnason, Landsbankinn: Post-Covid, it was built-up demand for travel and obviously savings had built up, as they did in many other countries. We are now two or three years into that, so that’s fading out as a factor.

We are seeing different measurements of inflation trickling down. That said, as we’re seeing in many other countries, inflation tends to be more sticky than anyone wants
Friedrich Luithlen, DZ Bank

For us it’s getting into a more modest area and that is key to moderate the inflation. So, if we get there in the coming months, then we should be able to see inflation coming down closer to target in the next two years or so. But it’s something that the market needs to see before believing. That’s the difference between Iceland and many other countries.

Luithlen, DZ: I can contribute a view from some of the more entrenched Nordic investors, how they see the economy and the danger from inflation. There are two elements to mention. Firstly, investors broadly agree with the view put forward in the latest S&P reports: look we don’t think there’s going to be a housing crisis. Even on the elevated rates level, Iceland is well insulated from that type of shock.

Secondly, there are healthy underlying economic dynamics in Iceland: a young population, low dependency rates, high participation of women in the workforce or a high GDP-per-capita ratio.

Those are the underlying factors that create an environment where people are happy to buy Icelandic debt. That holds also in the face of nominally high interest rate and current inflation levels around 6%.

Fildes, GC: So are the expectations for inflation to come down quite quickly now, like in certain other countries, or is it going to take a bit longer?

Höskuldsson, Arion: We’re hoping it will come down quickly. At least for Arion Bank, there’s a bit more pessimism it won’t happen quickly, and probably rates will be a bit more stubborn than we were hoping for.

Luithlen, DZ: Yes, I agree with that. We are seeing different measurements of inflation trickling down. That said, as we’re seeing in many other countries, inflation tends to be more sticky than anyone wants.

International bond markets

Fildes, GC: First of all it’s invisible and then it’s sticky. We can come back to various economic points but why don’t we quickly talk about Iceland issues in international markets? Hreiðar, the last roundtable in March was just before or just after you accessed the covered bond market for the first time and I think you got your timing to absolute perfection didn’t you? Something happened immediately afterwards.

Bjarnason, Landsbankinn: Yes, we did at the time. It’s been interesting. In the last few years, 2022 was quite difficult in foreign capital markets for sure… periphery countries with smaller issuers… 2023 we came back quite strongly. And this year has started very well for all the banks.

Fildes, GC: With the rates background helping?

Bjarnason, Landsbankinn: I don’t think that that’s been a big factor. But it’s often difficult for us to understand what drives spreads, in particular. Obviously the rates are one thing but the spreads that we have to deal with is another. It’s often difficult to see why it gets elevated and then as quickly comes down.

Höskuldsson, Arion: Like you said, we are a periphery country, it’s a smaller investor pool than in other countries, other banks. It means that the risks are a bit more volatile than for some of the more stable countries. It’s still great to see a recovery but it’s a bit puzzling. I’m mainly puzzled by how high the spreads went in 2022. Not much changed. Obviously the guys that bought into those transactions that we issued at that point have made very good returns on their investment.

Bjarnason, Landsbankinn: Tensions were high in the market and small issuers in those scales tend to be pressured more.

Höskuldsson, Arion: During this time as well, S&P was the key rating agency for the Icelandic banks; it’s changing a bit now. They downgraded the economic risk assessment of Iceland during this period. It’s difficult to say. It’s one part of it. It doesn’t help. And recently they upgraded it again. They published a positive report on the Icelandic economy, and especially the real estate sector, which they were worried about. That was a signal of confidence for the issuance.

Luithlen, DZ: We are in an extremely benign issuers’ market at the moment, with a rate trajectory that is much less ambiguous in the euro space than in US dollars. And that’s the overarching backdrop against which you issue. This is a good time to use that momentum, both in senior and in covered, to broaden the investor base and get more people involved across the EUR space.

Once you have new investors in your books and they do credit work for you, on the back of, “hey we need to invest anyway and look we can get a good pickup here”, then this will stabilise your market access over time.

Jens Hellerup, NIB: I think that is clearly what has happened over the last one and a half years, there has been spread compression both within the SSA sector but also between the SSA sector and covered bonds. Investors have been looking for a pick-up.

You can say that typically happens when there is no crisis, so of course it’s the exception now because a lot of things are happening around the world from a geopolitical point of view, so why is that happening now? Maybe the economy is better globally than expected and that’s the reason.

Luithlen, DZ: Not necessarily from a German perspective. [Laughter]

Hellerup, NIB: Well, maybe there is a lot of liquidity and investors need to invest.

Fildes, GC: Jens, it’s been five months since January that we’ve had a really strong bid for all kinds of bonds, without much let-up.

Hellerup, NIB: At least in our sector it has been very active in the first five months of the year. Then there is money around from bank treasuries and the central banks, but also from the asset manager and pension sector. We as an issuer are conservative, after the summer starts in September and with a US election in November the Autumn can be short.

Luithlen, DZ: We also see, especially on the covered side, the investment managers coming back to the market. Now that’s an interesting point, well, we have a bit of a weird situation.

We have seen new issue premia have come down, sometimes even pricing through the curves. But we are still at elevated spread levels historically in the rates space, both on the SSA side as well as on the covered side.

One explanation for that is everyone knows SSAs are issuing a lot; investors think about the relative value between SSA and covereds as two rates products. So, the €30bn more from the EU this year, KFW, EIB, all issuing at high capacity, and historically elevated levels, is preventing the spreads from tightening in the secondary markets. Additionally we have that disjunction between secondary and primary markets, which was extreme at the beginning of the year with everybody selling covereds. Why? Because they wanted to get the high new issue premia in the primary markets. You got to read that right.

But then there’s also all the liquidity that’s been building up in the eurozone because people are investing less in real estate. In Germany, as savings rates go up, at the end of the third quarter I think the number was €7.7tr in funds available for German retail, which is cash they have in the bank, investments with asset managers, their pension plans, etc. That’s a record volume and that money is available and needs a home.

Fildes, GC: They’re avoiding real estate?

Luithlen, DZ: Yes, because houses are still very expensive, rates are historically high, even though a lot lower than in Iceland. And if you want to refurbish your house, that’s still very costly because raw materials, wood, concrete, whatever you need, are also historically at high levels. So, what are people going to do? They’re going to save money and go to the asset managers and the pension funds. That’s one of the reasons why we have this benign issuers’ market at the moment.

Fildes, GC: Also maybe more liquidity, as the ECB is no longer buying everything and therefore it’s returning to a proper market and you’re beginning to see investors who were there pre-ECB coming back, or is that too much of a generalisation?

Luithlen, DZ: I’m not sure whether the ECB stepping out of the market is the main driver for the higher spreads. I think it’s the overall issuance volume that we see in SSA that anchors people’s expectations around where spreads should be. And the ECB is less of a general topic in the market now.

Frank Jackman, GC: Do you think the new investors, the tourist money, will stick around in the asset classes for a longer time?

Luithlen, DZ: Financial flows are going to flow where they think the best opportunities are. At the moment this isn’t real estate; this is actually financial products. And if you can, like Iceland, offer a pick-up, then you can attract significant new flows of capital. On the flip side and by the same token, not all of them are going to stick around, to answer your question.

Hellerup, NIB: I am not sure the Bank treasuries are tourist money. I think the banks had a huge deposit inflow during the years with negative yields as most banks offered 0% return during the time with negative central bank rates. You would expect when yields have gone up that retail money would have got an alternative investment opportunity to the bank deposits. This has not happened, so banks are still very liquid due to their retail deposits. So it’s still bank treasuries that are amongst the biggest investors in our bonds.

Bjarnason, Landsbankinn: Deposits have grown significantly in Iceland since the start of Covid. But surprisingly they have continued to grow quite well post covid, even though economic growth is strong and people are travelling and spending. It’s an interesting exchange because deposit beta is high in Iceland so people are not necessarily investing in other financial products, they’re fine with their deposits in cash. Obviously high interest rates are difficult for the stock market in many ways, so we’ve seen a lot of reduction in leverage exposures in the stock market as well.

The investor base

Fildes, GC: Have you noticed any change in the make-up of your investor base and where the interest is coming from?

Höskuldsson, Arion: We had a €300m senior issue on Tuesday [May 14] where we saw huge increase in demand.

Fildes, GC: And it went brilliantly, I hear.

Höskuldsson, Arion: Yes, we had a record book of €2.6bn (8.5 times book) and where the number of investors were around 190, which is a significantly larger number than we have seen in previous years. We saw increased interest across the board, including from the US, DACH and Apac regions as an example. Again, it’s much broader than we’ve seen in the last few years, which is very pleasing, because we are small and infrequent issuer in the Euro market. Like you were saying before, when you’ve done the analysis on Iceland, you’re more likely to do the future issues, you’re not doing the research just for one deal. So it’s very good to broaden the investor pool.

Luithlen, DZ: That is the main challenge when you look at euros or other currencies: What do we offer to investors? Do we go €500m but not very regularly? Or do we do €300m and then tap? How do we design continuous investor engagement both on granular and bulk level? Given the glass ceiling that the Icelandic banks face in terms of balance sheet growth, these are not trivial questions.

Höskuldsson, Arion: Especially in the covered space because we each have one benchmark. €500m is big for us, we are small banks. So doing a benchmark is a big decision. And then if you do one and you only need to have one outstanding, you’re waiting few years for the next one. You have to time it very well and you have to keep investors engaged without issuing more frequently.

Investor relations

Fildes, GC: Investor relations, post-Covid, is a really interesting topic because people are having to think again about how they do it. People are bored with video calls now — do we need to get back out travelling again? How are IR habits and techniques changing? What are you doing about it?

Hlöðversson, Íslandsbanki: We’re definitely using roadshows more than before. But we remain active in travelling and meeting people in person as well. It has to be said that obviously we are on the road for a potential selldown by the Icelandic government, so there are some synergies related to those. So we tend to do maybe ECM and DCM in the same trip.

Höskuldsson, Arion: At least from my perspective, we’re still doing roadshows, we still feel we have to meet people. And do the virtuals in between. So it’s good that we have more frequent interactions. That’s my experience.

Fildes, GC: And not just because there’s a deal coming?

Höskuldsson, Arion: No, we try to do it regularly.

Luithlen, DZ: You mentioned the shift to Moody’s — what was your experience? Could you also speak a bit towards targeting investors’ LCR pockets with a €500m trade and your considerations between having one or two ratings in senior and/or covereds?

Höskuldsson, Arion: All the Iceland banks used to be S&P-only for years post the financial crisis. A couple of years ago, Arion Bank added Moody’s. And that was very important. It is important to have more than one voice, more than one analyst looking at the country and a second opinion. Interestingly, at least from our perspective, we’ve been much higher rated by Moody’s than by S&P. So obviously there isn’t one true story, Moody’s has a different perspective which is fine.

It’s good to have two but also — we talked about our size, the difficulty of doing €500m, it’s also very complicated for a company of our size effectively having, with the regulator, three capital ratings, three liquidity ratings. It adds operational complexity for us.

So we had to measure that against the benefit of investors having two ratings and whether there was any impact on liquidity, on spreads. Our conclusion was that, for our issuance needs, having one credit rating was the conclusion. In the covered bond space, we had recently gotten a rating of AA2, which was quite supportive. And then, as mentioned before we did the deal this week, which was a testament of, at least on the senior side, that it is not negative from an investor perspective for us having one credit rating.

So yes, we want to have a very detailed discussion about this.

But we also need to regularly second guess that. That’s part of management’s responsibility. Having Moody’s now is not a decision forever, although it’s not a decision we make every year. We need to always consider should we now add another one, has our ratings requirement changed? Do we need to issue more and differently? It might be we need to have two ratings later on, but currently we think this was the right decision for us.

Luithlen, DZ: And to add to that, ratings are not cheap. So there needs to be a benefit to the costs.

Höskuldsson, Arion: Both in terms of direct but also indirect. There are a lot of indirect costs around this. So yes.

Bjarnason, Landsbankinn: I think it’s helpful that we now have two. Landsbankinn still has S&P and we will stick with that. But we might consider doing Moody’s also but again that’s doing two times the work and two times the costs without necessarily any direct benefit in terms of pricing etc. But even though we remain with S&P and not rely on Moody’s, it’s helped us that Moody’s is involved in rating our peers as it puts both S&P and Moody’s framework and ratings methodologies into perspective.

And we’ve seen that already; S&P has improved the underlying rating for Iceland, for the banking industry in Iceland, and we see opportunities for further improving the S&P ratings on par with Moody’s over the next year or two. So it’s important because it affects investor pockets for LCR and size is one thing but that’s difficult to get to on a regular basis because of the balance sheet limits that we have being purely domestically focused. So it’s been helpful and we saw an improvement from S&P earlier than we expected.

Hlöðversson, Íslandsbanki: It also brings management discipline, to go through this and engage with the rating agencies.

Höskuldsson, Arion: It was helpful for us to go through the Moody’s process, having to go through everything again and bring the case, starting from scratch. It was a very good process to go through.

Especially for Icelandic banks because relatively few asset managers have analysts that actually cover Iceland in depth. So it’s even more important that the credit rating gives a broader view than we would have with just one.

Green bonds

Fildes, GC: You mentioned that it brings management discipline. There’s a similar argument around green bond issuance as well. When an institution like a bank or a corporate does a green bond, that comes from the very top and everyone has to be involved and it brings a discipline. Green debt is emerging as an important part of Iceland bank and sovereign funding. The question is, has the launch of the debut Icelandic green sovereign bond affected bank issuance plans for labelled debt? Is this something you’re contemplating more or has it brought more liquidity?

Bjarnason, Landsbankinn: What we’ve done at Landsbankinn is: our euro senior preferred issuance has been exclusively in green format for the four benchmark issues. So we’ve built up an outstanding pool of €1.1bn in green bonds. For us it’s been an important factor, especially to increase the investor pool. And it has helped with pricing through the size of the order book and the possibilities to tighten in the process of issuing.

Hlöðversson, Íslandsbanki: I agree with that. To some extent it can be viewed as an investment. It doesn’t really make a huge difference in terms of pricing but it makes a difference in terms of size of order book both internationally and domestically. We’ve done it in both markets and when times are tougher, that’s the thing that will help us.

Fildes, GC: Did you notice that when times are tough the green format tended to perform slightly better?

Höskuldsson, Arion: Our record transaction this week wasn’t green. I wonder how much bigger record it would have been if it had been green. So it’s marginal I think, it does help, it does bring slightly broader pool of investors.

Iceland has huge potential in this area because we are all green energy. The challenge is trying to get it through the keyhole of the Taxonomy. But in the long run, Iceland has huge potential there. And to demonstrate that, it was great to see the sovereign issue a green bond
Hreiðar Bjarnason, Landsbankinn

Bjarnason, Landsbankinn: Especially in difficult markets it’s more important.

Luithlen, DZ: It adds a lot of execution certainty. We’ve done the Green debut deal for the Republic of Iceland. It was nine times oversubscribed. In a great market, of course people are going to flock to an issue like that. But in a difficult market, especially when you do sub benchmark and that’s what you are strategically committed to be doing, then an ESG format can be really helpful.

Bjarnason, Landsbankinn: It allows us in these types of market that we are in currently to broaden the investor base and as Ólafur was saying before, to have a more recognised name when times are tougher – which they tend to be every few years.

Luithlen, DZ: Would you have the scope to also issue covereds under a framework?

Bjarnason, Landsbankinn: It’s possible, yes.

Luithlen, DZ: So, you’re not following the paradigm, that cover pool has to be in green mortgages?

Bjarnason, Landsbankinn: We issue green under our sustainable finance framework. So it’s still not fully EU taxonomy aligned, that will take a few years. Especially for Iceland where the major industries in Iceland haven’t been fully described in the taxonomy. So that’s one of the challenges and that relates to the housing market as well.

Iceland has huge potential in this area because we are all green energy. The challenge is trying to get it through the keyhole of the taxonomy. But in the long run, Iceland has huge potential there. And to demonstrate that it was great to see the sovereign issue a green bond.

Fildes, GC: Although leading the way in green came from the supras really. So Jens, what about you and NIB’s green ESG activities?

Hellerup, NIB: We have issued green bonds since 2011 and more than €8bn has been issued over the years. It’s still only a small part like 10%-15% of our annual issuance which has been in green format. We have the environmental mandate but it’s still like we are only taking the best of the green assets and finance with a green bond. Investors appreciate it.

There is a lot happening with how investors are looking at green investments. In the beginning, some 10 years ago, it was very much focusing on the green programme and the green bonds. But now it’s much more about the issuers. Green investors are looking into the issuers’ ESG approach.

So, it doesn’t help that you come with a green bond that finances 10% of your assets and then you do the 90% of your lending in a non-sustainable way. That doesn’t work for the investors.

And this is maybe also why the greenium to some extent has disappeared, because if you go some years back there has probably been a couple of basis points or 3bp greenium. That has over the years disappeared. I know the last trade KFW did, two or three weeks ago, they were discussing that there was maybe 1bp greenium. It’s true that in a difficult market the green label helps the execution.

You see it more in the secondary market where green bonds can trade 2bp-3bp tighter than a conventional bond, as green bonds are more stable than other bonds because this is the last bond that an investor will sell.

Fildes, GC: Did the sovereign get any spread tightening because of the green sovereign issuance?

Luithlen, DC: I think they have four issues outstanding with a curve that could be more liquid. So, to answer the question in basis points is not entirely straightforward. We certainly saw additional demand because of the format.

Fildes, GC: GlobalCapital is launching a new product that actually captures things like this. Jens, tell us about the role of NIB in Iceland and what have you done, what are you doing, what are plans, including from a funding perspective?

Hellerup, NIB: We’ve been doing lending in Iceland since 1977 and we have financed more than 220 projects, for more than the equivalent of €3bn. Of course, we have the environmental mandate and with the importance of the renewable sector with geothermal energy in Iceland, it has been obvious for NIB to finance. We are also trying to support the SME sector in Iceland and that’s where the banks are helping us here. We can lend to them and then they can distribute it to the SME sector. So this is also an important segment for NIB.

That lending has basically been in euros and dollars but now we see more demand and we get the question if we can lend in ISK, which is also why I’m coming here to see if I can get ISK for lending, for example by issuing bonds in ISK.

For the investors we believe it is a good opportunity. They get good diversification, the investors get an AAA rated name, and they get a small spread over the government. I would also like to mention that the investors get a green investment opportunity as we are happy to issue a green bond in ISK. We would probably pay a spread over the government, of course the question is what should that spread be?

Fildes, GC: Are you going to swap it or are you going to keep it?

Hellerup, NIB: We would basically lend the proceeds from a ISK bond to the Icelandic clients. We have that demand for ISK from investors and from our lending clients, but we have not agreed on the level with the investors — where we see it and where the investors see it. We are probably about 10bp or 15bp away from each other.

Fildes, GC: Does the fact that you don’t have to swap it mean that you could probably?

We’ve been doing lending in Iceland since 1977 and we have financed more than 220 projects, for more than the equivalent of €3bn. Of course, we have the environmental mandate and with the importance of the renewable sector with geothermal energy in Iceland, it has been obvious for NIB to finance. We are also trying to support the SME sector in Iceland and that’s where the banks are helping us here
Jens Hellerup, NIB

Hellerup, NIB: We will keep it in ISK and lend it straight to clients here. The question is if that’s not working with the investors, we will also speak with the banks here about doing a swap. I understand there is not really a good cross-currency basis swap market, but I guess the banks have access to cheaper ISK from the retail market, and we have access to the dollar or euro market cheaper than the Icelandic banks. Why don’t we try to exchange this cash flow? I know we cannot call the banks and get a price tomorrow, but we have time to work out the swap opportunity.

Luithlen, DZ: By the way, that aspect of insulating the Icelandic economy from cross-currency risk — the classic scenario that we had back in the day of lending in FX to the housing market or retail clients in any way, shape or form — the way you manage that in Iceland now is definitely a positive.

To understand that EUR issuance does not create a potential macro balance of payments risk creates comfort in investing in euro-denominated Icelandic debt. EUR lending is limited to those industries, companies and agents that also have euros in their foreign exchange revenues. That’s definitely a positive that’s been mentioned to us from international investors.

Bjarnason, Landsbankinn: The local banks are quite restricted in terms of maintaining some foreign currency imbalances. Actually they have always been. But pre-2008, a lot of foreign currency was lent to borrowers in Iceland that didn’t have revenue in foreign currency. That was the kind of risk that doesn’t play well through the cycle.

So I guess from the Central Bank’s point of view, it would be fine if issuers like NIB would issue moderate amounts in ISK where they would swap it or do direct ISK lending in relation to that, especially if it’s not hot money investing in those ISK products, just for the AAA name. Because that could increase macro prudential risks if seen as hot money carry trades in significant amounts.

Hellerup, NIB: We have a very good dialogue with the Central Bank and Iceland is an owner of and represented on our Board, so there is an ongoing dialogue.

Banking sector

Fildes, GC: Let’s switch our focus to the Icelandic banking sector. How have the recent increase, which I think was in March 2024, to the counter-cyclical capital buffer, from 2% to 2.5%, and the introduction of an EU-aligned resolution directive, which was June 2023, impacted the Icelandic banking system?

Bjarnason, Landsbankinn: I would say that the latter one is a bigger factor than the counter-cyclical buffer, which was already expected to be taken up to the 2.5%. The BRRD II implementation is important in many ways, as it disciplines the funding plans and maintains the need for senior unsecured issuance being a significant part of bank funding. So a topic I guess for all of us and obviously not just in Iceland. Subordination requirement is also coming later this year so that again is something that is a constraint that we need to have a close look at when it comes to our capital planning.

One factor, which all the banks are working on, is building the unsecured market domestically. That is a relatively new debt space … so that is something we have all been spending quite a bit of time on to get the investor base educated
Ellert Hlöðversson, Íslandsbanki

Hlöðversson, Íslandsbanki: I would say one factor, which all the banks are working on, is building the unsecured market domestically. That is a relatively new debt space domestically so that is something that I know we have all been spending quite a bit of time on to get the investor base educated for these things.

Höskuldsson, Arion: It is quite unique actually. Even in our FX senior preferred, we don’t see Icelandic investors as part of the investor base. It is unique. Most issuers in Europe have a base domestic demand that they can count on. The Icelandic pension funds are the largest investors in Iceland. They [don’t] really have a large appetite for this as of yet; they buy the covereds in Iceland, they buy the equity but they haven’t been buying any large scale in the seniors. And this is, especially important now for an example because of the MREL requirements, we have a real requirement for this senior. It’s important for the domestic investors to understand this product.

Luithlen, DZ: The European asset managers like to hear that. When they look at your debt, they will go through a relative value analysis. They will consider the senior / covered differential and invest, where they see the better value. And then if you add senior non-preferred in EUR to the basket of choice for AMs, covering Icelandic banks looks more interesting. Hence, if the domestic pension funds are in no hurry to find senior non-preferred from the banks, international investors from the Asset Management Community will definitely like to take a closer look.

Hellerup, NIB: I think that’s education. You have seen in other Nordic countries they’ve had this senior non-preferred requirement for some years and the investor base has not been developed at all. That’s a role that NIB has taken as well; we are happy to go in and help these transactions and be an investor and try to crowd in money when we buy in to these trades. So this is another role we have had. I’m not sure we can call it developing capital markets but supporting a new product, which banks need to issue due to regulations, is a role NIB has taken on because we see the importance of a well-functioning financial market, especially in the role of supporting the SME sector. We have bought senior non preferred bonds from banks from most of the Nordic and Baltic countries and we will be able to do that in Iceland also.

Luithlen, DZ: In the local currency?

Hellerup, NIB: Yes, if I get the ISK (laughter). It is our role with NIB now, like with Iceland but also in the Baltic, to try to help local markets and it has been with the senior non-preferred requirements in the Nordic countries where we are helping that market and also banks in the Baltics.

Hlöðversson Íslandsbanki: It’s a transition. It takes time to educate the market. And there is another point to this, a nuance if you will. The current legislation framework for the pension funds doesn’t segregate covered bonds from the counterparty risk, as in most European jurisdictions. So when the pension funds are viewing their counterparty risk, they have to count the covered bonds, in addition to the equities, in addition to the senior, everything. That’s something I know at least I, and hopefully my colleagues, are pushing this. It’s a nuance.

Bjarnason, Landsbankinn: It’s very important to get that covered bond classification changed for the pension funds, because it’s been well established that covered bonds are a different risk, a completely different thing.

Höskuldsson, Arion: But on the capital point, it’s probably worthwhile for the record, the counter-cyclical buffer, of course the Iceland banks are extremely well capitalised. We’re 20% covered equity ratios and then we are standardised so leverage ratios is 12% plus, probably the highest you will see in Europe. It’s an important point from the credit risk perspective because there’s a lot of equity there.

Luithlen, DZ: It’s a factor of two roughly.

Höskuldsson, Arion: Two or even three.

Luithlen, DZ: Investors also mentioned that Iceland manages its volatility as a small open economy very well. There may be criticism around some aspects of the regulatory regime like the one that you mentioned just now. But on the whole, international investors appreciate the very steep and well executed learning curve from the global financial crisis fallout here in Iceland. That is a super-important aspect of the debt placeability in the long term.

Volcanic worries?

Fildes, GC: There’s been renewed volcanic activity on the Reykjanes Peninsula. Has it affected things, are you worried about it?

Bjarnason, Landsbankinn: It has. It continues. It’s an ongoing event and could last for decades as an ongoing event. It’s interesting because in Iceland we have a natural catastrophe insurance, which is mandatory for every real estate owner in Iceland. So when such a thing happens, it is a fully-funded vehicle that should compensate. And this happens when we get avalanches etc, people are compensated financially.

Luithlen, DZ: Who is underwriting that risk?

Bjarnason, Landsbankinn: It’s a fund, it’s basically an SPV within the government that collects fees from every real estate owner in Iceland every year and builds up funds and has done for a long time. And then they have a reinsurance from London to top it up five times. So it’s very well-funded.

The tricky thing, and even for Iceland this is unusual, is what is happening in Reykjanes. We have a town which has been evacuated and is uninhabitable. So people are not allowed to live there and haven’t been able to for six months and probably will not be allowed to live there for the coming years. However, only a small part of them have been compensated from the natural catastrophe insurance scheme, as most of the houses in the affected area are not directly. But you might have a 30m deep crack right next door.

Luithlen, DZ: It has to be direct damage?

Bjarnason, Landsbankinn: Yes. And that’s why the government set up this vehicle to buy up those assets from the individuals in the area funded partly by mortgage lenders in the area. So that has meant some credit risk for the banks as well. But it’s a nuance and in similar cases in Iceland, that should not be necessary because of the insurance scheme.

Hlöðversson, Íslandsbanki: If you look at it from a macro economic standpoint, the impact is limited. There is some impact on the housing market but the Central Bank has made this publication, was measuring it at 0.1% or 0.15% of GDP divergence. So it’s a limited effect. Obviously, there is a lot of uncertainty for the inhabitants of Grindavík and this government initiative has relieved them of the uncertainty.

Fildes, GC: Even if they might be still waiting for the money?

Hlöðversson, Íslandsbanki: Yes, that’s just time. I think that will be completed probably in the next few weeks. But it’s still very uncertain what will take place in Grindavík, and there are many potential scenarios. If there were to be an eruption within Grindavík and the volcano will ruin everything, then we have very clear lines on what will happen. But the most likely scenario is that nothing further will happen so, at some point, we will have to make decisions on what are we going to do with this town.

Luithlen, DC: From a human perspective it’s super-important that, especially in a community like Iceland, you have a sense of “everybody is in the same boat”, “on the same island”. This element of social cohesion and mutual solidarity can even be seen as credit positive.

Fildes, GC: Jens, I know the NIB was there supporting during Covid. I presume the NIB stands ready to help if required?

Hellerup, NIB: Of course we have a mandate for the environment and productivity. This would be outside the mandate but, as you said, during Covid the three Baltic countries got loans from us. I’m pretty sure the government can manage but of course it’s definitely something we would look at if we get the request. So there is the will within the Nordics to help if there is anything we can do. That’s at least what we did in the Baltics during Covid.

Bjarnason, Landsbankinn: Again, the magnitude of this is quite limited so it’s not on the Covid scale in terms of the effects on the overall economy as it is relatively contained within the affected area.

Hlöðversson, Íslandsbanki: And also, after Reykjanes, the volcanic systems at Reykjavik, everyone is probably a geologist in Iceland now. The volcanic systems, I’m told, are quite complicated and it may move elsewhere from the current fissure but we have made some risk assessments. For example, we believe that the capital area is not at risk currently.

Fildes, GC: I don’t know whether you would agree with this but I would say that it was actually the volcano that prompted the tourism burst in 2011. So, I presume for Iceland’s tourism economy at least, you need a volcano every few years or so, don’t you?

Hlöðversson, Íslandsbanki: And we need to keep in mind also one of our biggest national assets is a lot of pure green energy. And this is the counteract to that.

Bjarnason, Landsbankinn: That’s a good point because we have learnt to live with those things. Usually, we have such volcanic activity up in the highlands and/or in unpopulated areas. This time it’s closer. But geothermal energy for us is hugely important. The Blue Lagoon stems from it in this area but that also means that every few hundred years you get this activity where we see it now.

Hlöðversson, Íslandsbanki: Aside from a few back-up generators, we produce all our energy in a green manner from hydro plants or geothermal. District heating is widely spread, for example every house in Reykjavik has district heating from geothermal sources. And it’s obvious, you can’t really build geothermal plants outside of active volcanic fields if you will; that’s where the heat comes from. So these things are counteracts.

Fildes, GC: Are you any closer to exporting that energy?

Höskuldsson, Arion: Of course we export it mostly through aluminium smelters through local production. But no ammonium plants where you liquefy ammonium and you send it to the Germans to help, that doesn’t need to be — [laughter].

Also new industries — fish farming on land is utilising this energy. We’re seeing data centres coming up as a big industry here, based on the same energy source. So we’re exporting energy in various shapes or forms indirectly.

Hellerup, NIB: I guess the “storing of energy” [power trades] everyone would probably like to develop. I know it’s probably going slower than initially thought but that could be quite a big thing in Iceland with all the geothermal energy.

Fildes, GC: Icelink? Is that what it’s called?

Hellerup, NIB: Power-to-X where you use your renewable energy to split the water into oxygen and hydrogen.

Bjarnason, Landsbankinn: What’s been debated in Iceland for decades is the possibility of building a connector to Europe to export energy. But it’s controversial, for many reasons.

It’s a massively capital-intensive project but it’s doable. It has been done and absolutely, the Scandinavian countries have such connectors to Europe. So it’s definitely possible. It’s still on the political agenda to answer that question. Do we want to use the energy that we produce in Iceland to do something in Iceland? Or do we just want to export the raw material through a cable? That’s one of the questions. The national power company has looked into this, very detailed, and is very much for it if the politics get some consensus on it.

The project finance has got to be good if done and obviously it can work both ways so we can also import energy through such connectors. We can manage it day and night, etc.

Höskuldsson, Arion: This was discussed a lot, probably five or 10 years ago. There was a big discussion and analysis done on it and the politicians basically decided not to do it. So that discussion died down.

Fildes, GC: With Europe having had to shed itself, or trying to shed itself, of dependency on Russian gas, it might make a lot of sense.

Luithlen, DZ: I’m certainly no expert on any of this but I would imagine that should the Germans get around to building a gas transmission system which is usable for nitrogen, then we get the infrastructure that would allow new and other forms of energy exports.

Hlöðversson, Íslandsbanki: There are plans on both ammonia and nitrogen plants in the eastern part of Iceland, next to some wind farming. But who knows?

Hellerup, NIB: But wind is not big on Iceland is it?

Hlöðversson, Íslandsbanki: No, we have some development project but nothing really commercial. Someone told me but I’m also no expert that the problem is that we do not have stable wind — and usually too much.

Hellerup, NIB: And then if you cannot store the wind or the electricity and you have the geothermal energy for free anyway.

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