NatWest Group plc (NWG) Earnings Call Transcript & Summary

Good afternoon, and welcome to the NatWest Group H1 Results 2024 Fixed Income Update. Today's presentation will be hosted by CFO, Katie Murray and Treasurer, Donal Quaid. After the presentation, we will open up for questions. Katie, please go ahead.

Good afternoon, everyone. Thank you for joining our Q2 Fixed Income Results presentation. I'm joined today by Donal Quaid, our Treasurer; and Paul Pybus, our Head of Debt IR. I will take you through the headline to the first half before moving to the financials for the second quarter. And Donal will take you through the balance sheet, capital and liquidity, and then we'll open up for questions. We have had a strong first half with significant growth quarter-on-quarter. Income was GBP 7 billion and costs were GBP 4 billion, resulting in operating profit before tax of GBP 3 billion with attributable profit of GBP 2.1 billion. Our return on tangible equity was 16.4%. And given the strength of our performance, we are upgrading our 2024 guidance, which I'll talk more about later. We remain focused on generating capital in order to reinvest in the business and make shareholder distributions. Our CET1 ratio is within our target range at 13.6% and we increased capital through earnings as well as active management of risk-weighted assets, which added 140 basis points during the first half. As a result, this morning, we announced an interim dividend of 6p, up 9% on last year. This is in addition to the GBP 300 million on-market buyback announced in February, which completed this week and a directed buyback of GBP 1.24 billion that we did in May. Turning now to our 3 strategic priorities: disciplined growth, bank-wide simplification and active balance sheet and risk management. We have continued to build on our strong positions through both organic and inorganic activity. The growth in new customers of over 200,000 has contributed to growth across the bank. Lending and Commercial Banking to mid-market customers grew by GBP 1.8 billion and AUM are up 11% to over GBP 45 billion. We are accelerating this organic growth by making selective acquisitions where we have opportunities to add scale in our target areas at attractive returns. We announced today that we are acquiring a GBP 2.5 billion portfolio of prime U.K. residential mortgages from Metro Bank and we expect the deal to close in the second half of this year. Our Sainsbury's transaction is expected to complete in the first half of 2025, adding around 1 million new customer accounts with about GBP 2.5 billion of unsecured loans and GBP 2.6 billion of savings. We continue to simplify the bank to increase efficiency and improve customer experience. For example, we have 3 strategic hubs in the U.K., India and Poland, which we are reducing to 2 by closing our operations in Poland. Our third key priority is to deploy capital dynamically and maintain strong risk management. In addition to disciplined origination, we are actively managing our risk-weighted assets and have delivered a GBP 4.3 billion reduction in the first half using a range of means, including significant risk transfers and credit risk insurance. By focusing on disciplined growth, improving efficiency and managing our capital dynamically, we are driving capital generation in order to optimize shareholder returns. I'd like to talk now about our updated macro assumptions. Overall, the U.K. economy has performed better than we expected at the start of the year, and we are pleased to see consumer and business confidence returning. This means the Bank of England has not yet started to reduce interest rates. We initially assumed rates would start falling in May, reaching 4% by the end of 2024 and 3% by the end of 2025. We now assume that rates will start to come down in the third quarter reaching 4.75% by the end of the year with a further 5 cuts in 2025 to 3.5%. Of course, the actual outcome may be different. The headline rate of inflation is now 2%, in line with the Bank of England's target, and we assume that it will stay around this level. We continue to assume moderate real GDP growth and some increase in unemployment. I'd now like to talk about our financial performance in more detail. All of my comments use the first quarter as a comparator. Income, excluding all multiple items increased 5.2% to GBP 3.6 billion. Operating expenses were 2.3% lower at GBP 2 billion. We made an impairment release of GBP 45 million or 5 basis points of loans which included post model adjustment releases of GBP 117 million. Together, this delivered operating profit before tax of GBP 1.7 billion. Profit attributable to ordinary shareholders was GBP 1.2 billion and return on tangible equity was 18.5%. Turning now to income performance in more detail. Income, excluding notable items of GBP 3.6 billion was up 5.2% in the first quarter, with growth in both net interest income and noninterest income. Across the 3 businesses, income grew by GBP 147 million, driven by higher deposit income and fees. Group net interest margin was 210 basis points, up 5 basis points from the first quarter. Given this positive performance and our updated economic assumptions, we are raising our guidance for 2024 total income, excluding notable items to around GBP 14 billion. Turning to our deposit income drivers. For the first time in 2 years, the average rate of interest we pay on our customer deposit funding has stabilized. It remained at 2.1%, in line with the first quarter. This stabilization reflects modest changes in mix and limited adjustments to deposit product rates. As U.K. base rates came down, we expect to pass through reductions on our customer deposit rates. But clearly, the quantum and timing of this is subject to competition as well as contractual terms and conditions. We have updated our illustrative interest rate sensitivity on the right of the slide. The managed margin is more relevant in sensitivity for changes in the base rates and deposit pass-through. Based on our first half of balance sheet, a 25 basis point downward parallel shift in the yield curve would reduce annual income by GBP 125 million. This is mainly driven by our unhedged deposit balances and assumes a pass-through of around 60%. Turning now to the structural hedge. It is an important driver of income, so I will recap a few key points. GBP 175 billion or 41% of our deposit base is part of the product structural hedge, where yields are depressed relative to current rates. The yield in the first half was 1.58%. Our product structural hedge has an average duration of 2.5 years, which means it takes a full 5 years to reprice, and we reinvest maturing balances at the prevailing 5-year swap rate. As we show in the chart, before further reinvestment is taken into account, more than 90% of income is already written for 2024. And product hedges already written will deliver income of GBP 2.9 billion in both 2025 and 2026. The actual income from the structural hedge in coming years will reflect any changes in notional balances as well as the difference between the redemption and reinvestment yield. The product notional reduced by GBP 10 billion during the first half, which reflects our 12-month lookback at average eligible deposits. We continue to expect around GBP 170 billion by the end of this year based on a static balance sheet. Overall, we expect the product structural hedge to deliver higher income in 2024 than 2023. And for this to deliver a more significant income benefit in 2025 and 2026. Turning now to costs. We remain on track for other operating expenses to be broadly stable compared to 2023 excluding the increase in bank levies of around GBP 100 million and costs associated with the potential retail share offering of GBP 24 million. Other operating expenses of GBP 1.9 billion for the second quarter were slightly lower than the first as a result of the Bank of England levy. Severance, branch and property exit costs increased in the first half as we accelerated our work on simplification. The second quarter includes costs relating to our announced exit from Poland. Turning now to impairments. Our diversified prime loan book continues to perform well. We're reporting a net impairment release of GBP 45 million for the second quarter, taking the first half charge to GBP 48 million, equivalent to 3 basis points of loans. In retail banking, a charge of 12 basis points reflects broadly stable Stage 3 inflows, partially offset by further post-model adjustment releases. Commercial and Institutional reported a release of 28 basis points, driven by post model adjustment releases as well as a reduction in stage 3 impairments. Our balance sheet provision for expected credit loss still includes GBP 302 million of PMA for economic uncertainty. We have also reviewed and updated our economic scenarios, which drove a GBP 17 million release. We have included economic forecasts and weightings in our appendix. State 3 charges have remained low in the first half and as our economic scenarios are relatively stable, with little sign of deterioration, we now expect a loan impairment rate below 15 basis points for the full year. And finally, turning to guidance. For the full year 2024, we now expect income, excluding notable items, to be around GBP 14 billion. Other operating costs to be broadly stable with 2023, excluding additional bank levies of around GBP 100 million and retail offer costs of GBP 24 million and our loan impairment rate to be below 15 basis points. Together, this delivers an expected return on tangible equity of greater than 14%. Looking beyond 2024, we believe the business is well positioned to achieve our 2026 target for return on tangible equity of greater than 13% with a CET1 ratio in the range of 13% to 14%. And with that, I'll hand over to Donal.

Thanks, Katie. Good afternoon, and thank you for joining today's call. I will start by sharing some highlights for the first half before moving into more detail on the balance sheet, covering deposits, liquidity, lending and capital. I will then give an update on progress with our funding plans for the year. Starting with the highlights on Slide 14. We ended the first half with a strong capital MREL and leverage position comfortably above the regulatory minimum with a CET1 ratio of 13.6%, a total capital ratio of 19.5%, a leverage ratio of 5.2% and a total MREL ratio of 31.7%. Our liquidity coverage ratio was 151% giving us comfortable headroom over minimum requirements. Our loan-to-deposit ratio was 83%, and our net stable funding ratio was 139%. We ended the first half with GBP 425 billion of customer deposits across our retail, private and corporate deposit franchises. We have made solid progress with our funding plans year-to-date with GBP 3.8 billion equivalent of issuance from the holding company across senior MREL, Tier 2 and AT1 and GBP 4.3 billion equivalent from our operating company, NatWest Markets. And we have returned to the covered bond market for the first time since 2019, issuing GBP 750 million from NatWest Bank. Thank you for your continued support for these transactions. Turning to liquidity on Slide 15. Our liquidity position remains very strong. At the end of the first half, the LCR ratio was 151% or 147% on a 12-month rolling average reflecting around GBP 54.5 billion of surplus primary liquidity above minimum requirements. Our high-quality liquid asset pool totals GBP 227 billion, comprising primary liquidity of GBP 160 billion and secondary liquidity of GBP 67 million. Primary liquidity increased in H1 due to an increase in the customer funding surplus together with HoldCo and OpCo issuance. Secondary liquidity reduced due to the normal amortization of collateral prepositioned at the Bank of England. Cash balances with central banks represent around 70% of total primary liquidity at GBP 112 billion. The remaining 30% of primary liquidity mostly comprises highly rated Level 1 LCR securities with a smaller percentage of Level 2 LCR securities. We have GBP 12 billion currently drawn under the Bank of England's TFSME scheme with GBP 3.8 billion repayable in March '25 and the remainder repayable from March 2027. Looking at our customer deposits on Slide 16. Across our 3 businesses, deposits were up GBP 5.2 billion to GBP 425 billion. Migration from noninterest-bearing to interest-bearing deposits continued at a slow pace as expected. Noninterest-bearing balances were 32% of the total compared to 33% at the end of the first quarter and term accounts remained at 17%. In Retail Banking, there was strong growth in savings driven by record ISA inflows. In Private Banking, there was good demand for instant access savings, including some short-term transitory inflows. In commercial and institutional, both noninterest-bearing balances and savings grew driven by our commercial mid-market customers. Our loan-to-deposit ratio at the end of the second quarter was 83%, down from 84% at Q1. Turning to lending on Slide 17. Gross loans to customers across our 3 businesses decreased by GBP 1.9 billion to GBP 358.6 billion. Taking retail banking together with private banking, mortgage balances fell by GBP 0.8 billion as customer redemptions more than offset new lending. The pace of reduction slowed in the second quarter with gross new lending increasing over 20%, reflecting stronger market volumes and stable retention levels. We expect the book to return to net growth in the third quarter, given both stronger market volumes and an increase in our share of new applications during the second quarter. Unsecured balances increased by GBP 0.3 billion to GBP 16.1 billion, with continued growth in credit cards, partially offset by lower personal lending. We continue to grow our share of unsecured lending and the Sainsbury's Bank transaction will support this. Within commercial and institutional, lending to mid-market customers grew by GBP 1 billion driven by demand in social housing, asset financing and invoice financing. Balances in Corporate & Institutions decreased by GBP 1.9 billion, partially due to customers taking advantage of stronger capital markets which is reflective in the performance of NatWest Markets. Turning to our capital and leverage position on Slide 18. Our CET1 ratio at the end of the quarter was 13.6% within our target range of 13% to 14%. We are operating with 310 basis points of headroom above the maximum distributable amount of 10.5%. Our U.K. leverage ratio decreased by 10 basis points in the quarter to 5.2%, leaving around 135 basis points of headroom above the Bank of England minimum requirements. The slide also shows the impact of the other systemically important institution buffer for NatWest Holdings that results in a group risk add-on for NatWest Group of 1.2%. Although not part of minimum regular requirements or combined buffer requirements for NatWest Group, it is included in our minimum supervisory requirements. Looking at the drivers of CET1 on Slide 19. Capital generation was especially strong given our impairment release and active RWA management. We generated 63 basis points of capital from earnings and 41 basis points from lower risk-weighted assets. RWAs decreased by GBP 5.5 billion to GBP 180.8 billion. Active capital management accounted for GBP 3.9 billion of this reduction. This activity is in line with plan with a number of actions successfully completed in the second quarter. And whilst it is an important capital management tool, it should not be considered the run rate going forward. We currently expect around GBP 200 billion of risk-weighted assets by the end of 2025. Growth will not be linear, and we will include the impacts of the Metro and Sainsbury's transactions, further RWA management and ongoing regulatory headwinds. We are still awaiting publication of the final Basel 3.1 rules, and we are also liaising with the regulator on CRD IV model changes where we expect some further inflation in the second half of this year and through 2025, although timing and quantum remains uncertain. We will continue to operate with a CET1 ratio in the range of 13% to 14%. Turning to our total capital and MREL positions on Slide 20. Our total capital ratio for the half year was 19.5%. We currently have an AT1 ratio of 2.6% with GBP 4.7 billion of securities outstanding. Two of these securities with a total nominal of GBP 2.65 billion have their first call in 2025. Our Tier 2 ratio was 3.3% with GBP 5.9 billion of securities outstanding. We are currently running excess headroom in AT1 and Tier 2 given recent issuance. However, over time, we expect to continue operating with optimal levels of AT1 and Tier 2 capital relative to our minimum requirements. Our total MREL continues to look healthy at 31.7%, significantly higher than our risk-weighted asset requirements. And finally, turning to our issuance during the first half on Slide 21. From NatWest Group, we have issued GBP 2.8 billion in senior MREL against our guidance of GBP 4 billion to GBP 5 billion equivalent for the year. In addition to issuing MREL, we have also issued GBP 1 billion in each of Tier 2 and AT1 in H1. While for NatWest Markets Plc, we have issued around GBP 4.3 billion equivalent in euros and dollars which leaves us well placed against our GBP 3 billion to GBP 5 billion guidance for 2024. From NatWest Bank, we issued GBP 750 million covered bond within our guidance of up to GBP 1 billion for the year. Looking ahead to H2, we expect to be active from both the holding company and NatWest Markets to complete our annual funding requirements and will also give consideration to the potential of prefunding our 2025 requirements if the right market conditions prevail later in the year. With that, we'll open up the line for questions.

[Operator Instructions] Our first 2 questions come from Lee from Citigroup. What is the sum total measured in RWA terms of SRT that are currently in existence? What is your capacity to do further SRTs? And when do you an SRT -- when you do, sorry, an SRT, does that mean that the risk is permanently removed from the balance sheet? And the second question is what part of your loan book is of the greatest focus presently sector or loan -- type of loan?

Thanks very much, Lee. I'll just deal with the first one. The reality is, Lee, there's no 1 bit of the loan book that I would call out. I mean, overall, as you can see by the charge and the write-backs we've had in the quarter, in reality, the book is performing incredibly well. Clearly, we're very focused on all different parts of the group, but there's not one area that I would call out particularly ahead of any of the others. Donal, do you want to deal with the SRT question?

Yes. So on the SRT, Lee, we don't disclose the total sum, but just I suppose to help you in some degree in the Pillar 3, you'll see in terms of the SRT transactions we executed in Q2, they deliver about GBP 1.2 billion benefit to risk weights. You'll also see there that the nominal value of the SRTs has increased from GBP 2.3 billion to GBP 5.8 billion. So I think you can use that to assume that the existing transactions that are already on the book before Q2 weren't going to be material in terms of that order benefits. On capacity, I think plenty of capacity, we do have aspirations to build up the program from a low base. And then the final part of that does it permanently remove the risk weight from the on the book. The answer is no, just for the lifetime of the transaction, but we do want to get into a more consistent rolling program so that we can roll these transactions going forward as well. So hopefully that answers your questions.

Our next question is pre-submitted. Could you elaborate a bit on the funding for H2? It looks like you have more work to do on MREL potentially, Tier 2. Any thoughts on currency?

Donal?

Yes. I'd say very well advanced on our funding plans for 2024. In MREL, in particular, we did guide in February of GBP 4 billion to GBP 5 billion equivalent for the year. We've done GBP 2.2 billion, yes. So we're just above kind of 50% of that requirement. So do expect us to be active in H2 with, I would guess, at least a couple of transactions. As always, we're open on currency depending on where the investor demand is and also from a pricing perspective as well. So we consider that on an ongoing basis. Maybe just touch on other elements on AT1 and Tier 2. We're looking, I think, pretty much complete. I think AT1, we set up to GBP 1 billion. We did a GBP 1 billion transaction. And on Tier 2, we guided to GBP 1 billion to GBP 2 billion, and we're just shy of the GBP 1 billion at GBP 800 million equivalent saying that, we will keep an open mind just depending on market dynamics in H2 and if there is good opportunities, then we will look at that. From an OpCo perspective, NatWest Markets plc, we guided to GBP 3 billion to GBP 5 billion for the year and we're very well placed there. We've done about GBP 4.3 billion equivalent across euros and dollars. And the same that I probably do expect to be active from the OpCo as well in H2.

[Operator Instructions] Our next question is the impairment charge of 3 basis points for the half year is very low. What would it take to move impairments higher? And when do you think the rate will normalize?

Yes. Thanks very much. It's a great question. As I look at the charge for the moment, it's -- we've changed our guidance today to be less than 15 basis points. When we look at our kind of through-the-cycle guidance, we've traditionally talked about 20 to 30 basis points. But I mean what I would say is for the last number of years, certainly since COVID we really struggled to kind of hit that level. I think the real reality with the strength of the kind of deposits that our customers are holding and now the improving kind of economy. It's very hard to call when you might actually see us getting back to that through the cycle guidance. It's clearly not something we're anticipating this year with less than 15 basis points. We continue to obviously to be very vigilant on the book. and spend a lot of time looking at different kind of sectors. But as I said in one of the earlier comments, there's nothing particularly that I'm looking at that's causing us over concern, but we do continue to watch for developments.

Our next question comes from Paul Fenner. [Operator Instructions]

I've got 2 questions. One on the supply front. Just to clarify. So you mentioned Tier 2 that there seems to be a gap there between your plan and what you've done so far? Or is there not a gap are you saying that you're more likely not to have any more need than you were to doing another transaction just to clarify your Tier 2 needs going forward. And then the other question I had was you've got the management provision buffer of 300 odd. Just to get an understanding of how you might go about releasing that. if rates stock coming down, presumably the risks assuming there isn't -- it isn't for a slowdown in economic reasons. All other things being equal, rates come down, unemployment, assuming it doesn't go up, the cycle seems to be softer. Does that mean there's kind of like a more or less linear glide path to 0? Or does it -- is it never going to go to 0? What's kind of the -- what's the bottom of that -- what's the minimum amount that you are likely to hold in your management provision buffer? I know that's not what you call it, but whatever.