NatWest Group plc (NWG) Earnings Call Transcript & Summary

First of all, thank you very much to Alison Rose, Chief Executive of NatWest Group to joining us today. It's a real pleasure for us here at Goldman Sachs to welcome you again to our conference this year in Paris. I'm sure no particular introduction is needed, but I do it anyway, very briefly. Alison was appointed to a [ prudent ] role in November 2019, having gained the wealth of frontline banking experience during her long-term career at NatWest. So Alison, many thanks again for making time and joining us at this year's conference.

Maybe just to start off with a broader topic. One of the main investor concerns remains the outlook on the broader U.K. economy, just on the back of this [indiscernible] high inflation [ print ]. And I was just wondering if you could share your view on the macro outlook, particularly on the outlook with regard to inflation and the potential impact of central bank policy [ action ].

Yes. So look, I think I'd start with the -- and by the way, it's great to be here as well. So thank you for having me, as always, good to catch up. So look, I think where I'd start with is, our strategy has always been to build all-weather balance sheet. And I think the strength of our balance sheet is really designed to navigate through sort of these macro periods. And the way I would describe it is, we're well protected against any downside macro view, but we're also well positioned for any upside view in terms of ability to deploy, to [ grow ] in responsible way. And that really underpins the guidance we've given in terms of the various shape of our business, the 13% to 14% CET1 and the 14% to 16% return on tangible equity in the medium term. So I think that's really the starting point with a largely secured balance sheet that's growing. I think on the macro, what we've seen is obviously, inflation is being a little bit more persistent and a little bit more sticky, which is requiring more interest rate rises to come through. And that is adding different dynamics to the market. But what we're seeing in the U.K. is a really strong underlying resilience. If I look at the performance of our book, consumers are behaving in a very rational way. We're seeing no increase in defaults or impairments and the same on the business side, really strong resilience, very low levels of impairments and very rational behavior in terms of spending. In fact, what we've actually seen is an increase in confidence now that we're going through a little bit of a sort of movement in the [ swap ] curve at the moment that's actual good underlying confidence. In fact, the [ ONS ] data said investment in the U.K. increased in the first quarter versus a negative trend in Q4. And when I'm sort of up and down the country, I was in the Midlands last week talking to a group of manufacturers and consumer businesses very confident and feeling very relaxed. So what I would say is against that sort of macro uncertainty, I would say, credit quality impacts are likely to be less because we're in a very sort of resilient and confident perspective. I think now with market implied higher rates, you're going to see impacts on both margins and volumes and customer behavior mix, and we'll update our macro assumptions. But over -- underpinning that from our perspective, the all-weather balance sheet really positions us well for this scenario with still underlying resilient performance from our customers.

Great. Let's move to revenue outlook. And obviously, interest rates are over 400 basis points higher in the U.K. over the course of the last 1.5 years. And I was just wondering how shall we think about the outlook for NII from here? What are the main moving parts in terms of margin? And could you also touch on your latest [indiscernible] relation with regard to deposits and in particular also customer behavior?

Yes. So look, I think a number of the moving parts. First one is the sort of balance sheet, which is positioned for upside. We've obviously benefited in our business from rising interest rates. We've seen a strong improvement in NII, 30% higher than previous years. But we've also seen very strong lending growth in our business as well. So the growth has been both a benefit from interest rate-wise, but also underlying lending growth you saw in Q1. We had GBP 5.7 billion of lending growth that was broadly spread across our business. And it's growing GBP 27 billion since 2021, and that's back to the kind of organic growth that we have in our business. So I think balance sheet is positioned for growth NII and obviously, with deposits, which is the very significant deposit surplus that built up during COVID, that's obviously reducing slowly. But that surplus liquidity has been a benefit for us, and we're seeing that surplus sort of reduce as a result of inflation and spending behavior. So I think balance sheet position for growth NII continues to benefit from higher interest rates and our positioning. I think on customer behavior, what you're seeing is liquidity tightening. And that really is the impact of [ Q2 ] and obviously, TFSME refinancing that's -- they're going to come across the market and repayments. So the market is competitive on deposit pricing, and we are seeing deposit surplus levels, system liquidity slowly reduce and [indiscernible] customer behavior [indiscernible]. We're seeing customers adjust their spending habits for the macro environment. In some instances, what we're seeing is customers with higher deposits actually using the opportunity to pay down more expensive debt. We've seen a bit of early repayment of mortgages, more expensive debt we paid. We're actually seeing in the business side with that increased confidence, businesses paying -- using some of their surplus liquidity to pay down more expensive debt. So quite rational behavior, but we are still -- we are seeing sort of liquidity tighten. Our approach to that is we're going to manage our liquidity through a number of lenses. Deposits have income value and liquidity value for us. So we'll balance how we deal with that. So what does that mean for NIM, which is always the magic question. We've guided for this year that NIM will be around 320 basis points. In Q1, it was higher at around 327 basis points. In Q1, we would expect NIM to continue to reduce. Now that's as a result of the volume mix that we're seeing. So although you've got the rate increase coming through, even with that partial benefit, don't forget the timing of that, we are seeing the liquidity reduced. So there's going to be a volume mix point. So we would expect NIM to reduce quarter-on-quarter, and we retain our guidance. Obviously, there's also the pass-through of deposit rates. We've always said that the higher the rates go, we would expect to pass-through more of that higher rates as we balance both sides of our balance sheet and manage our liquidity, our overall cumulative pass-through is around 45%. But on some of the more recent rises, we're closer to 80%. So that's just how we're balancing it. So look, we'll give you an update at half 1, but our guidance of 320 sort of NIM, and we expect it to continue to reduce through the quarters. So I think that's the sort of the shape of balance sheet and the moving parts. So I think volume and mix and macro dynamics playing through.

Great. It's great. Let's dig in a little bit more on volume than in terms of loan growth. Obviously, strong performance of NatWest in the first quarter, I think GBP 5.7 billion growth. I was just wondering going forward, which opportunities are you most excited about? Is it more of the same, so more in mortgages? Or could there be also other areas such as credit cards in terms of market share gains?

Yes. I mean one of the things I'm really happy about in terms of the shape of our business and the franchises that we have with second largest mortgage lender in the U.K., the largest commercial bank in the U.K. with very strong positions and a very strong Wealth business as well. And so I still remain very excited about the capacity to grow. And that GBP 5.7 billion, the GBP 21 billion I talked about in terms of overall lending growth is showing you that we are continuing to organically grow our core franchises, which are capital generative businesses. Doing that responsibly. Our book is a prime book, 93% secured, good disciplined growth, and I remain very happy about that growth. Even in a lower volume mortgage market, for example, with where we are, that is a good asset class for us, and we continue to grow that responsibly. So we're still very excited about the growth we're delivering in our core franchises and within that risk discipline that we have. But I'm also -- and if you look at in the consumer business, we'll grow mortgages, still really happy with that. We'll grow unsecured. We're starting from a low base. Our market share is now at [ 7.2% ]. We're now a whole of market, good credit quality coming through. Our Wealth business in affluent is growing really positively, and on our corporate and institutional business, our very strong positioning, green and sustainable funding and financing is delivering really good underlying growth. The new areas. We've just completed on our acquisition of Cushon, which is workplace pensions, which sits really strongly alongside our Commercial and Wealth business. Vodeno, which is a partnership that we've built through banking as a service, we think that's a really good long-term growth opportunity as well. So across those elements, I think, good responsible lending, but I'm excited about capacity to grow and track record of growing and new areas of growth as well.

Yes. You mentioned net interest income has increased 30%. Obviously, with that, the share of other income as a percent of total revenue has decreased now around 25%. I was just wondering what you see as the main growth driver for other income, and this is much of a focus?

Yes. I mean it's a really strong focus for us as we can continue to develop the mix in our business. Obviously, there is a driver driven by customer behavior. We're really pleased to see the recovery in transaction banking and fees as business activity continues unsecured, we're developing more fee income and on the wealth side as well. And obviously, our NatWest Markets business, a very strong performance in Q1 as that business is starting to finish -- has finished the strategic refocus and is delivering. So we're obviously getting an oversized improvement in NII because of the rate moves as a bigger proportion, but underlying that growth in our balance sheet mix. It depends on customer activity and behavior, which is why I'm really pleased to see business confidence and investment coming back. And we have really strong market-leading positions, for example, in asset financing and invoice financing, which is a real dynamic that we're seeing picked up by businesses at the moment, particularly as they evolve their business model with productivity. I said I was in the Midlands last week, I spent some time with a great business there, very traditional business that we're financing all their acquisitions of robotics as they improve productivity and growth in their business. So those elements are really going to continue to diversify customer behavior, confidence, but also the diversification here.

Great. Let's move to cost then. Obviously, the high inflation print in the U.K. I was just wondering how much of a [ concern ] is that in terms of managing your cost base?

Yes. Look, I mean, we are a recipient of inflation like everybody else. And clearly, with that being a little bit more sticky, that's a challenge. We're very comfortable with our cost guidance for this year. We've guided to a cost base of GBP 7.6 billion for this year that includes around GBP 300 million of direct costs from Ulster and so around the cost-to-income ratio of around 52% sort of moving to 50% as we go forward. But we built into our forecast for this year. We put a lot of support in for our colleagues. For this year, there was some one-off cash payments that went in through January. So you can see our cost base is absorbing a higher cost as we go forward. So we're very comfortable with our guidance. And I always say this and nobody believes me, it won't be linear. So we expect our costs in the first half of the year to be higher than the second half of the year as our sort of cost trajectory changes, but we remain comfortable with the sort of 7.6% for the year. And our team have a really good track record across discipline. It will be -- it's -- we'll manage the challenges of inflation. It will be different issues that we have to look at. But all of our investment is geared around enhanced efficiency productivity as we're investing in technology and AI. But it won't be linear. High cost in the first half, but our guidance remains the same. That's exactly the phasing that we planned.

And then maybe related to this point, NatWest has been taking out cost for pretty much the bulk of the last 15 years ever since the global financial crisis. And I was just wondering how much scope is there still for additional efficiency measures. And in that regard, the newest debate is on the potential impacts of AI. Do we have any early thoughts on that?

Yes. I mean we have a good track record of cost delivery and discipline, and we very much see continuing operating leverage improvements that we can take out of the business. Obviously, we -- like any big organization, a lot of our cost is fixed, cost is focused around staff and property, and we continue to involve that. But big investments in operational efficiency. Our customer journey program where we're sort of reengineering our journeys, which have the benefit of higher productivity, lower cost and better control are really delivering both customer acquisition and improved efficiency. I have to give the example of our account opening, straight through processing. It's gone from 17% straight-through processing to north of 70%. That's just an example of what we're doing on operating efficiency. And there's more of that to come, and we will continue to invest in doing that. We've been using AI for a number of years in terms of robotics and natural language processing and our chat bots and how we enhance that. And I think that offers continued more improvement for both productivity, greater insight, our personalization strategy, which is a core part of our growth really enables us to target growth as well as more efficiency and delivery. So our cost discipline will remain, 52% cost-income ratio this year at 50% on an ongoing basis, but real discipline around operating leverage.

Great. Very clear. Let's move to asset quality and obviously, impact of high inflation on cost of living in the U.K., potentially impact of slowing economy. I was just wondering how worried are you about the loan book? And secondly, are there any early signs you noticed in terms of changes in asset quality?

Yes. I mean, look, I think one of the things around our balance sheet is it's very resilient. And what we're seeing is really resilient sort of performance from our customers. We've guided 20 to 30 basis points and impairments for this year. You saw in Q1, it was 7 basis points. In fact, we saw sort of provision releases across our sort of commercial [ brokers ] rather than sort of impairment. So what we're seeing is the underlying strength of the balance sheet, that largely secured prime book that we have is performing in a good way. We still think procyclicality will come, but we're not seeing any signs of that. So we're very comfortable with that sort of 20 to 30 basis points, and I think credit quality is going to be more benign. We're not seeing any material signs of distress. So we look at lots of indicators, both hard and soft, whether that is the number of calls that come into our financial health and support team, mortgage [ arrears ], early warning indicators in terms of increased usage of spend data, and we're not seeing signs of distress. So I think that's an important element of that risk discipline and robust balance sheet. So look, I think there are challenges in the economy. And obviously, there is a sort of decile performance across consumers, lower decile households really struggling with high inflation, high interest rates, typically not borrowers, significant borrowers of ours. And we're putting a lot of proactive help and advice and support out to customers to help them manage what is a cost-of-living squeeze, but overall impairments remain very, very low at this point, and we're not seeing any material shift, but we're obviously monitoring it very closely and being very proactive in the outlook.

Maybe just to follow up on this. I was just wondering how worried you are about commercial real estate, commercial real estate traditional areas susceptible to losses in economic downturns, and it seems to be compound that is turnaround by change in working patterns and working from home. I was just wondering how do you see your CRE exposure and also, if you are concerned about your office CRE exposure?

Yes. I mean, commercial real estate is a sector that we actively manage very, very closely and have done for a number of years. I mean, if you think pre-financial crisis, RBS's commercial real estate was north of 20% of our overall book with an average loan-to-value of 164%. That's not a great place to be. Our commercial real estate book today is less than 5% with an average loan to value of 47%. So it is a very different book, we manage it as a vertical, and it is something that we have actively been reducing and changing the mix over multiple years. It's not something that we've only just paid attention to. So -- and we've increasingly over the last 5, 6, 7 years shifted more into industrial, sort of out of retail and more into industrial, and we manage it very much, and it's very well diversified across all of the regions of the U.K., so no big areas of concentration. We also stress in on a regular basis. So we run it through multiple stresses both in terms of valuation and usage and mix, and there's nothing in there that causes us any cause for concern as we look at that book.

Great. Let's move to returns. One of the main discussion points regarding [ Atlas ] is on the level of return on equity the group can achieve. And you raised the target to 14% to 16% last July. Interest rates, the outlook for interest rates and the interest rates kept rising. I was just wondering what kind of returns can the group achieve and what would happen if at some point, rates are to be lower again?

Yes. I mean I mean in Q1, we printed a 19.8% return on tangible equity and very, very strong performance. We're very comfortable with our 14% to 16% sort of medium-term guidance on our ROTE, it really is the nature of the mix and the shape of the business that we've developed. Our view is this year, we will be at the upper end of that range. So just to be clear, I'm not capping the range, as you can see, but we would expect to be at the upper end. And there were puts and takes in the dynamics of the delivery of that. There's obviously been some positive sort of additions to that around higher interest rates, continuing sort of benign environment, you have very good lending growth, our core organic growth that I was talking about and that mix of credit. But on the other side, lower volume growth is obviously an aspect. And the forecast is that inflation will come down and rates will come down. So there's a volume mix point there, but we remain comfortable with that 14% to 16% sort of sustainable return that we've been talking about.

Great. Obviously, with higher returns comes scope for higher capital return, and I was just wondering in terms of potential headwinds on the capital side coming from regulatory changes, there was some fragility in the banking system in the U.S., in Europe. Do you see some [ narrates ] in terms of some recalibration of some of the frameworks, whether that's deposit insurance or some other parts of the regulation?

Yes. I mean capital return remains a key aspect of our sort of investment story and that capital generative business, I think. Since I took over, we've given over GBP 12 billion back to shareholders, and that continues to be a poor part of what we want to do. I mean I think some of the volatility you've seen in the banking sector has been quite idiosyncratic in terms of as we look at the different dimensions. Our liquidity portfolio is very robust, LCR of 139%. We've got a largely liquid portfolio. Our bond portfolio is a relatively small part of our book. And it is obviously mark-to-market on a rate immediately. So I think some of the regulatory change from some of the market fragility will be U.S. regional focused. I think the U.K. market has a very robust sort of resolution regime and very well capitalized and very well regulated. So I'm not expecting anything there. I mean, clearly, there's a lot of discussion around deposit insurance, again, slightly different structure in the U.K. to the rest of the market. And I think the major concern is not the fact that banks can't be resolved. It's what is the impact on customers with what happens. And so I think that's something that's being looked at. And if I look at our customer base, just under 70% of our consumer customers are caught within the retail deposit protection scheme and on the business side, it's less but a different dynamic. So I think that's definitely an area that the regulator is looking at, but I think it's more around how would you manage in a resolution scenario, how you would allow accounts to continue to operate and money back to customers. I think any change like that is going to take some time. It's not going to happen overnight, and we would continue to be sort of part of being involved in that. So that's one aspect. [ Basel 3.1 ] in terms of what's happening, we've built into our sort of forecast and trajectory and guidance that we've given you a 5% to 10% increase in RWAs, which includes our assumptions on [ Basel 3.1 ] and procyclicality and sort of other changes. So I think we -- we're comfortable with what's there, is built in deposits area that's being looked at, but any regulatory change will take some time, and we'll sort of keep a close eye on it.

Great. You mentioned the large capital return. And I was just wondering, NatWest shares now trades roughly at 1x book value. I was just wondering whether the changes...

[indiscernible] undervalued, don't we? [indiscernible] undervalued.

I just wonder whether the change is anything in terms of how you think about types of capital returns. So buyback was obviously an important feature. And also in that regard, your dividend payout ratio, ordinary dividend payout ratio of 40% in light of the high return, particularly at the moment of 19.8%, [indiscernible] which came a little bit towards the low end of the European banking sector. How do you think about capital return?

Yes. I mean the capital returns, I think I've been very clear and very consistent. Returning capital to our shareholders is a core part of our strategy. We've developed a capital-generative business. And we've given GBP 12.2 billion back to shareholders. There are multiple tools that are used to return capital to shareholders, ordinary dividends with a 40% payout ratio, we're very comfortable with that. I think no plans to change that. But we'll also use specials if we think that's appropriate. Direct to buyback, we continue to use that, and we recently completed a directed buyback of GBP 1.3 billion, which brings the government shareholding to below 40%. We think that's a good use of capital. And obviously, buybacks, we are GBP 800 million buyback that we announced is almost complete. So I think there are multiple tools that we use, and I've used all of those tools to deploy capital back with the [ DBB ] that we've just done. For the first time, we're within our 13% to 14% CET1 ratio range at 13.7%. And our business continues to accrete capital. Our preference is to deploy that to shareholders. We do have excess capital. I've talked before about and I get asked a lot about M&A opportunities. They would have to have compelling strategic value. You've seen we've done a number of number of things, which really sort of work for us in terms of adding to capability and range and growth trajectory for the business. So I think within that mix, 13% to 14% is the right CET1 ratio. We're generating capital. Our preference is to pay a record return to shareholders. And I think within all of that, I've got enough tools to continue to be able to do that.

Great. And I have one more question before opening up the Q&A from the audience. I was just wondering in terms of broader strategy and transformation. It feels the transformation journey is coming to an end with the disposal of -- on exit of Ulster Bank. But just wondering what's next for NatWest in terms of -- if you look at the setup, are there areas where you feel underrepresented? Are you -- are there any areas on the other hand where you feel overrepresented?

Yes. I mean, look, I think we've made good strategic progress. I think the sort of the big elements of transformation of sort of reshaping the corridor of the bank with the exit of Ulster and the reshaping of NatWest Markets are coming to conclusion. The core transformation within the bank where we're continuing to invest in data and technology and innovation and partnerships are really ongoing elements of our investment, really continuing to drive both productivity and value and growth. And I think that, that's clearly an area, the next investment cycle. We're investing another GBP 3.5 billion in the business. We will continue to invest in our data and technology. And the 3 sort of core areas that I talked about in February where we really think we can amplify our strategy and our growth through our personalization strategy, which is really allowing us to acquire and deepen the relationships with our customers. Embedded finance, which we see as a real area of opportunity and continuing growth and value and the sustainability transition where we have a really strong position, and I've committed GBP 100 billion to fund and finance the transition to net zero. Broadly GBP 40 billion of that has been deployed, and we see good dynamics in continuing growth, really good commercial dynamics and that just to give you a sense. In some of the research that we did last year, we think there's GBP 175 billion revenue opportunity, 260,000 new jobs and 30,000 new businesses that could be created within SMEs in the U.K. as being part of that transition, and that's something we're working really hard to deliver. So those 3 areas, we think, are real areas of investment in growth, obviously, continuing to invest in data and AI. I think AI offers a really exciting opportunity to continue around [indiscernible] for efficiency or productivity. I talk about being a relationship bank for a digital world that is really empowering and deepening those relationships. So yes, big heavy lifting on the troublesome aspects of our transformation, which were not increasing value, continuing momentum on our quarter transformation, which is growth and building in the capability. We have capacity to grow. We're still underweight and unsecured. We can grow. We've just moved into a whole of market with good risk discipline. Our wealth business is making very good returns and starting to grow very successfully in terms of our affluent delivery, but we have more capacity to grow in that area in our Commercial & Institutional business, deepening relationships in that business ecosystem and value accretion still there. So there still remain a lot of transformation, but value transformation that we're continuing to [ commit ] to.

Great. Let's open up for questions from the audience. Well, it seems like we covered most of the things. In that case, Alison, thank you very much for joining us this year at our conference. We really appreciate you making time.

Yes. Thank you for having me.