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NatWest Group - Income falls as trading dries up

Nicholas Hyett, Equity Analyst | 29 April 2021 | A A A
NatWest Group - Income falls as trading dries up

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NatWest Group plc Ord GBP1

Sell: 211.60 | Buy: 211.80 | Change 1.00 (0.47%)
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NatWest reported first quarter income of £2.7bn, down 15.9%. That was driven by lower fee income as the group saw a slowdown in its NatWest Markets business and reduced transactional activity compared to last year.

£102m of bad loan provisions releases, compared to an £802m impairment last year, meant profits hit £620m, up from £288m a year ago.

The bank did not pay a dividend in the quarter, although it did buy back £1.2bn of shares from the government, reducing the government stake to 59.8%.

The shares fell 2.2% in early trading.

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Our view

The ongoing work to shrink investment bank, NatWest Markets, means NatWest (formerly RBS) is generating most of its revenues from interest payments these days.

Generally, that makes for a more stable source of revenue, but at the moment it has the potential to cause headaches. 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.

However, NatWest has been able to offset that headwind by growing its loan book. Mortgage lending has accelerated and the bank's large SME customer base drew some £13bn in from government supported coronavirus lending schemes in 2020. However, both of these are relatively low interest rate products. With nervous consumers paying down higher interest credit-card and overdraft debt, the make-up of the bank's loan book is less profitable.

The good news is that default rates in the loan book have been significantly lower than the bank had feared. That's resulted in a big decline in provision for bad loans, plus some historic provisions have been released, boosting profits substantially. Releases could grow over the remainder of the year, as NatWest's small business clients recover when lockdowns end.

But for all the moves in the income and profit lines over the last year, it's the balance sheet that really pops off the page. NatWest's running on a Common Equity Tier (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 planned exit from the Republic of Ireland should free up yet more capital in the coming years - with a EUR4bn loan book already earmarked for sale.

NatWest might be justifiably peeved at having its dividend payments restricted by the regulator when its balance sheet is practically overflowing with capital. However, the real question is what the bank intends to do with something in the region of £7.0bn of surplus capital going forwards. Dividends are back, but we suspect trimming the government's stake in the business will take priority over dividend growth. The bank has approval to buy up to 4.99% of its share back from the government each year.

The risk of the UK economy nosediving, and bad loans mounting remain. 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: 0.56
  • 10 year average Price/Book ratio: 0.99
  • Prospective dividend yield (next 12 months): 4.7%

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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First Quarter Results

NatWest reported net interest income in the first quarter of £1.9bn, broadly in-line with the same period last year. That reflects a 2.1% increase in loans to customers, particularly in mortgages, offset by a lower net interest margin which fell from 1.89% a year ago to 1.64% this quarter.

Non-interest income fell 40.3% to £728m. That reflects a big decline in trading activity, down from £592m a year ago to £160m this quarter as well as a £100m decline in fees and commissions.

Operating expenses remain broadly flat, with the bank's cost to income ratio rising to 67.8% as a result. A better than expected performance across the loan book resulted in a modest impairment release (details above).

The bank reported a CET1 ratio (a key measure of banking capitalisation) of 18.2%, up from 16.6% a year ago, but down on the 18.5% reported at the start of 2021. That includes a dividend accrual of £547m for the quarter.

The bank reported a return on tangible equity of 7.9% in the quarter, better than the 3.6% reported last year.

Guidance for the full year remains unchanged.

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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 Refinitiv. 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.