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NatWest - profits wiped out by bad loan provisions

Nicholas Hyett, Equity Analyst | 31 July 2020 | A A A
NatWest - profits wiped out by bad loan provisions

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NatWest Group plc Ord GBP1

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NatWest, formerly Royal Bank of Scotland, reported total income for the second quarter of £2.7bn, down 34.4% year-on-year. That was driven by declines in the retail and commercial banks, with the investment bank delivering an underlying improvement.

A substantial increase in impairments for bad loans meant the bank fell to an operating loss in the quarter of £1.3bn.

NatWest expects further impairments during the rest of the year.

The shares fell 1.4% in early trading.

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Our view

Given it went into the crisis loaded with capital, NatWest might feel the pressure from regulators to cancel its dividends was a bit unfair. Despite a spike in commercial lending and a hefty provision for defaults the group is even better capitalised now than at the start of the year.

Having said that, a bit of caution probably doesn't go amiss in the current environment.

Efforts to shrink the investment bank, NatWest Markets, mean the bank is generating an increasing proportion of revenues from interest payments. That makes the recent cut to base rates painful - with interest rates on savings accounts already on the floor banks can't push funding costs much lower, but competition and regulatory action means the interest rates it can charge borrowers has fallen. That's an unpleasant combination for loan profitability.

It doesn't help that NatWest is notable for its sizeable SME business. Despite government support smaller companies will be hit hard by the current lockdowns, and the bank expects to add to the billions of provisions for bad loans it's already made over the remainder of the year.

It's not at all the start NatWest's recently installed CEO Alison Rose would have wanted.

She had been targeting significant efficiencies, especially through digitisation and rationalising the, arguably sub-scale, NatWest Markets. However, both projects are expensive, and while there have been some early signs of success, whether further progress can be delivered in the new environment remains to be seen.

However, investing is a long term game and a balance sheet that's practically overflowing with capital should allow NatWest to weather a spell of poor results. Our real concern is that with low interest rates here to stay, and the smaller investment bank generating lower levels of fee income, it's hard to see where income growth is going to come from in the near term.

A strong capital position means NatWest could emerge from the current crisis in better shape than rivals, with a larger loan book, stronger balance sheet and potential for a faster return to dividends. However, whether that's enough to attract investors to a bank which is still 62% owned by the UK government with limited growth opportunities remains to be seen.

Natwest key facts

  • Price/Book ratio: 0.3
  • 10 year average Price/Book ratio: 0.6
  • Prospective yield: 3.7%

We've introduced this section in response to recent survey feedback.

Please remember yields are variable and not a reliable indicator of future income. Keep in mind key figures shouldn't be looked at on their own - it's important to understand the big picture.

Half Year Results

Total lending to customers has increased 7.8% since the start of the year to £352.3bn. That reflects an increase in corporate lending driven by lending under government support schemes, offset by a slight reduction in lending on credit cards and other personal finance products.

Despite the increase in lending, quarterly net interest income fell slightly quarter-on-quarter to £1.9bn. That reflects a lower net interest margin, the difference between what the bank charges on loans and pays on deposits, now at 1.54% compared to 1.70% in the first 3 months of the year.

Non-interest income fell 37.2% quarter-on-quarter to £766m. That reflects the continued wind down of some parts of investment bank NatWest Markets and lower overdraft fees in the UK Personal Bank.

NatWest added another £2.1bn to bad loan provisions during the quarter, taking the total for the half to £2.9bn. This reflects the banks more pessimistic outlook for the UK economy, with the majority of the provisions coming from the Commercial Bank.

Total operating expenses rose 3.7% quarter-on-quarter to £1.9bn, although were lower than last year. The bank decreased headcount both year-on-year and quarter-on-quarter as the shift from physical to digital continues.

NatWest's CET1 ratio, a key measure of banking capitalisation, improved during the quarter to 17.2% (from 16.6% in Q1). That reflects the no-payment of dividends and a slight decline in risk weighted assets.

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This article is original Hargreaves Lansdown content, published by Hargreaves Lansdown. Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Thomson Reuters. These estimates are not a reliable indicator of future performance. Yields are variable and not guaranteed. Investments rise and fall in value so investors could make a loss.

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