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NatWest - some very real progress

Nicholas Hyett, Equity Analyst | 30 October 2020 | A A A
NatWest - some very real progress

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NatWest Group plc Ord GBP1

Sell: 260.80 | Buy: 261.00 | Change -2.30 (-0.87%)
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NatWest reported a 16.5% fall in third quarter revenues, which came in at £2.4bn. However, the nonrecurrence of PPI related costs and lower operating expenses meant the group reported a £148m profit for the quarter. That's despite a slight increase in bad loan provisions, and compares favourably to a £209m reported loss this time last year.

The bank did not discuss the potential for a return to paying dividends.

The shares rose 2.2% in early trading.

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Our view

Efforts to shrink the investment bank, NatWest Markets, mean NatWest (formerly RBS) is generating an increasing proportion of revenues from interest payments.

Generally that makes for a more stable source of revenue, but it also means the recent cut to the Bank of England base rate is 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 are falling. That's an unpleasant combination for loan profitability. The possibility of negative interest rates from the Bank of England would be uncharted territory, but would almost certainly make matters worse.

So far NatWest has offset the fall in profitability by hiking the amount on loan. Mortgage lending has accelerated and the bank's large SME customer base has drawn some £13bn from government supported coronavirus lending schemes.

So far the extra borrowing in times of distress isn't being accompanied by increased bad loans. The bank set aside billions earlier in the year to offset expected increases in defaults. Many had expected that to need topping up in the third quarter, but loan impairments are actually only up modestly on the same period last year. That's pushed the bank from a major loss to a modest profit in just a quarter.

But while the income and profit lines are moving around a lot at the moment, it's the balance sheet that really pops off the page. At the third quarter NatWest reported a CET1 ratio of 18.2%. That's ludicrously high - reflecting both internally generated capital as well as the decline in "risk weighted assets" or "RWAs" which forms the dominator of the CET1 ratio. The decline in RWAs largely reflects the exit from some activities in NatWest Markets.

NatWest might be justifiably peeved at being ordered by the regulator not to pay dividends when its balance sheet is practically overflowing with capital. However, the real question is what the bank intends to do with that surplus going forwards. We suspect trimming the government's 62% stake in the business is top of the list - which at the current market price could be bought in its entirety for £9.3bn. That's not out of reach over the next few years, especially if management were prepared to forgo dividend payments for a while longer.

The risk of the UK economy nosediving, and bad loans mounting remains substantial. And the stubbornly low interest rate environment will hamper income growth for some time. However, investing is a long-term game, and a balance sheet awash with capital should allow NatWest to weather a spell of poor results. The bank that emerges will be both smaller and duller than what went before, but ultimately that may be no bad thing.

Natwest key facts

  • Price/Book ratio: 0.3
  • 10 year average Price/Book ratio: 0.6
  • Prospective yield: 3.9%

All ratios are sourced from Refinitiv. 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.

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Third Quarter Results

NatWest's interest income fell 4% in the third quarter, despite a notably resilient performance in the commercial bank. The bank benefitted from a 12.5% increase in interest earning assets to £468bn, offsetting most of the decline in net interest margins (the difference between what the bank charge on loans and pays to depositors) which fell from 1.97% to 1.65%.

Non-interest income fell 44.6% year-on-year to £497m, as growth in NatWest Markets failed to offset significant declines in the retail and commercial banks.

Provisions for bad loans in the quarter came in at £254m, up a bit on the £213m reported last year but well below the £2.1bn record in the second quarter. Operating expenses fell 32.8% year-on-year to £1.8bn and also declined quarter-on-quarter - with litigation, strategic and other expenses all showing improvements. The bank reported an overall cost:income ratio of 74.5%, down from 92.9% a year ago.

The bank finished the quarter with a CET1 ratio of 18.2%, up from 17.2% last quarter and 16.2% at the start of the year. The improvement reflects internally generated capital and a significant decline in Risk Weighted Assets in NatWest Markets.

The bank generated a return on equity in the quarter of 0.8%, compared to a negative return of 3.8% a year ago.

The bank now expects full year bad loan provisions to be at the lower end of its £3.5bn-£4.5bn guidance range, as defaults remain limited.

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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.

This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing. Please see our full non-independent research for more information.