NatWest Group plc (NWG) Earnings Call Transcript & Summary

Good afternoon, and welcome to the NatWest Group Q3 2021 Results Treasurer Q&A with Donal Quaid. [Operator Instructions] I'll now hand over to Donal Quaid. Donal, please go ahead.

Good afternoon, and thank you for joining today's call. I will share some of our highlights from Q3 before moving into more detail on capital and liquidity and progress on our funding plans for 2021, and then we'll open up for questions. Starting with Slide 3. We're reporting an operating profit of GBP 1.1 billion, up from GBP 400 million for the same quarter last year. This includes an impairment release of GBP 242 million as underlying credit metrics improved and defaults remained low, resulting in an attributable profit of GBP 674 million. We continue to make good progress on our targets. Net lending was up 3.1% on an annualized basis driven by growth in mortgage lending. Costs were down 4.3% for the first 9 months compared to the same period in 2020, and we're reporting a CET1 ratio of 18.7%. Our liquidity position remains strong with an LCR ratio of 166%, and we've made excellent progress against our issuance plans. With market conditions being very favorable for issuers year-to-date, we have met our capital requirements for the year, leaving an opportunity for Senior MREL and opco transactions during the remainder of the year as we start to consider 2022 funding requirements. Looking at business activity more closely on Slide 4. Net lending across our retail and commercial businesses is up 3.1% on an annualized basis to GBP 305 billion, excluding government lending schemes. This growth has been driven by mortgage lending as commercial demand continues to be relatively muted across the market. U.K. mortgage growth of GBP 2.5 billion or 1.4% reflects continued robust demand following the first deadline for stamp duty relief at the end of June. In unsecured lending, we are seeing good momentum. Issuance of new credit cards has almost doubled year-on-year, and we've brought new products to market. Spending on credit cards is up 20% on last September to pre-COVID levels. And while credit card balances remain slightly down, the trend is gradually reversing. Turning to Commercial Banking. Demand remains relatively muted from smaller businesses, but we are seeing more activity in our corporate and specialized businesses. Revolving credit facility utilization remains broadly stable at 19% compared to a peak of 40% in April last year. Looking at government lending schemes. Since the first anniversary of these schemes when repayment started, about 7% of our bounce-back loans have been repaid in full and around 90% of customers due to start repayments are repaying on or ahead of schedule. Whilst all these trends are positive, we continue to monitor customer behavior closely in the light of recent supply chain challenges and inflationary cost pressures. Turning now to Slide 5. Given the increasing expectation of interest rate rises here in the U.K., including the material move in swap rates since October, we've provided an indication of the potential impact the rate rises may have on NII in 2022. We revised our economic assumptions and rate sensitivity at the half year results, and they will not be updated until the year-end, in line with our usual process that we note the improved consensus rate outlook. At the half year, the yield curve suggested that U.K. base rates would remain at 10 basis points until Q4 '22 before rising to 25 basis points. A further hike to 50 basis points was expected in Q4 '23. You will see the majority of our sensitivity comes from our managed margin or the unhedged balance sheet. This shows a benefit of GBP 414 million from an upward shift in the yield curve from 10 to 35 basis points. This reduces in years 2 and 3, reflecting higher pass-through assumptions as base rate increases. The overall benefit from 100 basis points increase would be GBP 1.3 billion in year 1, which shows you the sensitivity is not linear. Looking at mortgage rates. Margins are returning to levels seen pre-COVID. Average application margins in the third quarter reduced by 37 basis points to 115 basis points, and they continue to reduce towards the end of the quarter to around 105 basis points, reflecting the higher swap rates. This is broadly in line with January 2020. Front book margins and mortgages that completed in the third quarter decreased from 165 to 143 basis points, below the back book. Lower margin roll-offs resulted in the back book margin improving by 1 basis point to 164 basis points. The increase in swap rates in Q3 was followed by a further sharp rise in October. Unlike other lenders, we have taken action to increase customer rates across a selection of our products. Of course, the other side of the equation is the benefit we derive from higher swap rates through our structural hedge. We have said that the majority of the GBP 250 million year-on-year decline in our hedge income was in the first half and the hedge impact in the third quarter relative to the second quarter was negligible. We also expect the hedge impact on net interest margin to be broadly neutral in Q4. Turning now to impairments on Slide 6. We are reporting a third quarter net impairment release of GBP 242 million or 26 basis points of gross customer loans. This brings the overall release for the first 9 months to GBP 949 million. The Q3 release was driven by improved underlying risk metrics in our performing book and a continued low level of defaults. We continue to expect a net release for the full year with 3 key variables affecting the outcome. First and foremost, economic performance versus the weighted economic outlook we use in our scenarios. We update these every 6 months, so the consensus economic outlook as we approach the year end will be critical. Second, credit performance. While we see a low level of defaults and no tall trees at the moment, we will monitor credit conditions carefully as COVID support continues to roll off. And third, our post-model adjustments. Our ECL provision at the end of Q3 was GBP 4.5 billion, down from GBP 4.9 billion at Q2. This includes GBP 1.1 billion of post-model adjustments, of which GBP 729 million relates to economic uncertainty. If economic and credit conditions continue to trend in line with the third quarter, there could be some unwind of this PMA later this year and in 2022. Turning to capital and liquidity on Slide 7. Our CET1 ratio is now between 470 and 570 basis points above our 13% to 14% target range at 18.7% and is more than double our maximum distributable amount. We still expect to operate within a range of 13% to 14% by full year '23 and you will find more details of the CET1 ratio drivers in our Appendix on Page 22. Our U.K. leverage ratio of 5.9% is 265 basis points above the Bank of England minimum requirements. We've also maintained strong liquidity levels with a high-quality liquid asset pool and a stable diverse funding base. Our liquidity coverage ratio increased in the quarter to 166% due to deposit inflows and headroom above our minimum requirement is now GBP 79 billion. Moving to Slide 8 on our quarterly movements in CET1 and risk-weighted assets. We ended the quarter with a common equity Tier 1 ratio of 18.7% on a transitional basis under IFRS 9, up 50 basis points over the second quarter. RWAs decreased GBP 3.2 billion in the quarter to GBP 160 billion. This was driven by lower market risk, which decreased by GBP 2.9 billion, reflecting the GBP 2.4 billion model update following the upcoming cessation of sterling LIBOR. As we look to the year-end, for NatWest Markets, we no longer expect to achieve the majority of the remaining RWA reduction towards the medium-term target of GBP 20 billion this year. However, we now expect group risk-weighted assets to be below our previously guided GBP 185 billion to GBP 195 billion on the 1st of January 2022. Earlier this month, the PRA announced that they have deferred the Other Systemically Important Institution Buffer review for a further year with no new rate set until December 2023, barring any unforeseen changes in circumstances. In effect, any change in the buffer in December 2023 would not take effect until January 2025. In addition, the Financial Policy Committee announced its intention to consult on a proposal to change the metric used to determine the O-SII buffer rate for total assets to the U.K. leverage exposure measure. The FPC had previously stated they expect to maintain the countercyclical buffer at 0% until at least the end of this year. Any increase would not be expected to take effect until the end of 2022 at the earliest, in line with the standard implementation period. On Slide 9, you can see that deposit levels remained elevated during the quarter, although the rate of growth across our Retail and Commercial Banking businesses is slowing compared to earlier in the year. Customer deposits increased GBP 9 billion during the quarter with a GBP 2.2 billion increase in Retail and a GBP 2.3 billion increase in Commercial. Retail Banking deposits are now GBP 186 billion, and Commercial Banking deposits at GBP 178 billion at the end of Q3. Our loan-to-deposit ratio is 76%, underpinning our strong liquidity and funding position as well as our strong ability to lend. And we continue to look at all options available to us to assess the optimal blend and most cost-effective means of funding. Finally, looking back at our issuance year-to-date on Slide 10. I'm very pleased with the transactions we executed during the quarter and, again, thank you for your continued participation. On MREL, we've made excellent progress towards our end-state requirements, and in September, we issued a EUR 1 billion Senior MREL from the holding company, taking our issuance for the year to approximately GBP 3 billion at the lower end of our GBP 3 billion to GBP 5 billion guidance. On capital, we completed our Tier 2 requirements in September with an issuance of EUR 750 million, taking total Tier 2 issuance to approximately EUR 1.7 billion for the year versus our guidance of approximately EUR 2 billion. And we continued our capital optimization actions calling our $2.65 billion AT1 in August. From NatWest Markets opco, we issued $1.3 billion 5-year under our 144a program with a total issuance of approximately $3.4 billion completed by the end of Q3. Looking ahead to Q4 and subject to market conditions, we could look at some prefinancing of 2022 MREL and NatWest Markets opco requirements. So Katie has joined me in the room for questions. And with that, we can open up for Q&A.

[Operator Instructions] And our first question asks, can you elaborate on the potential for Q4 issuance, currency and tenor? Are you looking to do anything in ESG format?

Thanks. Yes. I should take that question. We'll consider currency and tenor, I think, at the time of any issuance subject to market conditions, liquidity and pricing in each currency as per normal. I would say that the rate moves over recent weeks in Sterling have made Sterling look attractive at present. As I mentioned in my opening remarks, we've completed our requirement for AT1 and Tier 2 for the year. So no further requirements in this space. It will be Senior MREL from the holding company. So I do expect at least 1 more transaction in Senior MREL given the -- well, subject to continued favorable market conditions. We've also previously stated our ambition for at least 25% of our MREL issuance to being green, social and sustainable format. And this year, we've issued 3 Senior MREL deals in total, of which 1 was our euro social bond. So to date, we have GSS issuance of approximately 30%. So to meet our 25% target, I think if we do another MREL deal, it is likely to be in green, social and sustainable format. And then in addition, as I said as well, subject to market conditions, we may look at additional opco transactions for NatWest markets.

Our next question asks, capital continues to increase quarter-on-quarter and moves further away from your 13% to 14% target. Are you still confident of getting to your target by 2023.

Like to kick off on that one, Katie?

Yes, I'll start on that one, Donal. Thanks very much. So absolutely right. It's a great position to be in to be in a bank that's sole capital generative. I would say that we are confident on the 13% to 14%. And if you look at the analyst slide, I think the -- it was even in the back of the equity side as well. There's a very nice slide which kind of takes you through all of the things that will come off as we go through. And in there, there's an important part of regulatory impacts as mortgage floors hit us next week as long as some smaller adjustments around IFRS 9 and software capitalization. But the other piece is, well, of course, we have been very strong in capital distribution this year but expect to continue to do that as we move into next year using a combination of dividends, directed buybacks and the recent end-market buyback that is going well for us. It's something we'd certainly look at again. So overall, I'm comfortable at this stage, it will get down to 13% to 14%. Thanks, Dave.

[Operator Instructions] Our next question asks, thank you for the rate sensitivity disclosure, which is very clear. Can I ask what are the key drivers of movement in the rate sensitivity? And how could actual income differ from disclosure?

Donal, why don't you take that?

I'll take that one. You've had enough of those questions this morning, Katie. So in terms of rate sensitivity, it's sensitive to both our pass-through assumptions and the level of deposits we have on the balance sheet. So a change in either will impact the sensitivity. So actual income can differ from what is outlined in the sensitivity disclosure. In terms of pass-through assumptions, they are subject to competitive environment at the time, and they'll need to be reviewed and adjusted, subject to the prevailing market conditions and as rates move higher. In addition, decisions and pass-through assumptions also influenced the underlying deposit balances as rates move higher as well. As you know, our sensitivity has increased over the last 18 months as we've seen significantly higher deposit balances. And then I suppose the last point to note is that the sensitivity is based on the parallel shift in the yield curve, which we rarely see. However, that's less of an issue for the managed margin component and more of an influence on the structural hedge.

Our next question asks, can you give me an update on where you are with legacy securities? What's left to do?

Donal, it feels that one's for you.

Yes. Thank you. So we continue to make good progress on legacy securities. And as you've seen actions we've taken earlier on in the year, less so in Q3 but more so in H1 through security calls and liability management exercises. So that will continue in a proactive manner as we move into 2022. At the end of Q3, I think we have approximately about GBP 2.5 billion, GBP 2.6 billion of legacy securities outstanding. Out of that total, there's about GBP 600 million regulatory calls post the end of this year and a further GBP 1.5 billion of securities that are either callable or mature over 2002 (sic) [ 2022 ], 2023. So I think the way to look at it is post the end of 2023, we expect to have less than GBP 500 million outstanding. So very, very comfortable where we sit today.

[Operator Instructions] Our next question asks, following the PRA's Climate Change Adaptation Report, do you expect a climate capital requirement in the future? And if so, over what time frame?

Do you want me to take that, Katie?

Why don't you start and I can always add?

Well, I'm obviously still working through the release in the PRA as well. But I think the piece that came out of it was that they see the capital framework is useful to address consequences of climate change such as material changes to financial risks associated with specific assets. So I think that probably makes sense, I think in terms of first view that if there is an increase in terms of financial risk you hold in your balance sheet that, that is reflected through capital requirements. However, from a timing perspective, I think it's early stages. And we liaise with the PRA and the Bank of England over coming months and into 2022. Katie, if you have any strong view?

No. I mean, look, I think the base was an important step forward. I think, ultimately, we'll get there. I think that's inevitable and those with greener balance sheets will be rewarded. But let's -- I think it's going to take some time. So I think we just continue to work. And all of us, I think, collectively understand how it might ultimately be structured.

Our next question asks, can you provide any guidance or indication of future plans to address Ulster Bank-related bond issuance, including legacy-old first active debt in light of a commentary in regard to winding down Ulster Bank over a 2-year time period?

Yes. Let me take that one. So you will have seen that there was a recent consent solicitation on some of the outstanding UBI DAC RMBS issuance. So that was successful a couple of weeks ago as well. So in terms of outside of that, there is very, very little market issuance outstanding. And I think in terms of the low notionals that do remain, we'll just look to address them over the time of the withdrawal as well.

[Operator Instructions] And Donal, at this stage, we have no further questions. I'll hand back to you for any kind of concluding remarks. And I'll let you know if any more do come through in the meantime.

Perfect. Thank you, Dave. Just thank you to everyone again for taking the time to join. And I'm sure we'll be in contact soon. Thank you very much.

Thank you.