NatWest Group plc (NWG) Earnings Call Transcript & Summary

All right. Okay. Thanks, everyone, for joining us. This is the Barclays Global Financial Services Conference. I'm delighted to be joined by NatWest Group CEO, Paul Thwaite. For those who don't know, I'm Aman Rakkar, lead coverage of the U.K. banks of Barclays. Thank you very much for coming and joining us today. Just by way of intro for Paul, Paul has been at NatWest for close to 30 years across a number of roles. You were appointed as CEO in July 2023, previously the CEO of the corporate and institutional bank but has hold -- held various roles across the bank and closely involved in formulation strategy. So anyway, thanks very much, Paul. Really appreciate you making yourself available and joining us here. Let's kick off the discussion.

So U.K. macro, it feels like the U.K. is at an inflection point. Inflation is falling, interest rates are falling. Critical backdrop feels more stable following this summer's general election. Given your unique vantage point, I would be interested in your assessment of the operating environment.

Great. It's good to be here. Thanks for the invitation. I appreciate it. I think in general, I agree with your kind of -- your thesis there around an inflection point. I think if you look at the U.K. over the last arguably 8 to 10 months, I think the indicators have probably been better than most people anticipated, be it GDP, be it house price growth, et cetera. And we've certainly seen that in terms of our customer sentiment data, both our own sentiment, kind of customer sentiment, but also the market data as well. Admittedly, coming from a low base on the consumer side more so than the business side. But there's been to all intents and purposes, 8 to 10 months of improving kind of customer sentiment. And that's rippled through to good customer activity on both sides of the balance sheet. So on the economic side, I would say better than anticipated. I think the operating environment, to the other part of your question, is encouraging. You can see a recovery in mortgage volumes, which is good, especially the last 2, 3 months. business demand is there. There's definitely conversations. There's definitely engagement. You can see the system-level growth. It's starting to come through, but bodes well, I would say. And on the political side, we have the election. It's a clearing event. It's a decisive outcome. It came earlier than I guess most would have originally anticipated. So you put that together, I guess, the economic, the operating environment and the political. And it feels like those dynamics have settled. And that is reflected in how clients and customers feel, put off a low base in terms of certainly the consumer segment. So yes, it's -- I think it's been an interesting 8 to 10 months. And I think we have an interesting couple of years ahead of us. The other thing to mention around, I guess, the new government is we have the budget coming up in about 5, 6 weeks. I think that's a key moment in terms of clarity around policy, the fiscal plan, what that supports. So I think that will help as well help with that broader inflection and stability.

Turning to the business itself. And so NII has been a key positive in recent results updates, inflecting positively ahead of expectations after a period of pressure. Can you talk to the major drivers of revenue from here? And indeed, can we expect continued growth in top line from this?

I think the most encouraging thing about the revenue picture, as you said, we've had 2 strong quarters. And it -- but the growth has been broad-based. We're adding customers in all 3 of our customer franchises. To me, that's a key indicator of kind of business health. So that's strong. What you can also see is that there are clear, absolutely clear lines of growth in each of those businesses. So whether it's our commercial mid-market business growing, whether it's our consumer credit business, whether it's our assets under management in our private business. So you can see that there's -- that growth is broad-based, which is great. If you look at half 2, how to think about revenue. We upgraded our guidance at half 1. You're aware of that. We upgraded to around GBP 14 billion. We've delivered GBP 7 billion in the first half. That's a pretty strong start. You can see that, As I've alluded to, loan demand is certainly returning in the mortgage side. So when I look out for half 2, you can see potential volume growth on the loan side, which is great. We've been pleased with the margin expansion in all 3 of our businesses. That's 2 quarters on the runway where you've seen each of our 3 businesses widen margins. That's very encouraging. Obviously, we're going to have the potential for more rate rises. So that's something that kind of blows the other way. But on the positive side, we're through the inflection point on mortgages. So front book mortgage pricing is pretty much the same as the stock. So that's behind us. So that headwind disappears, we've got the deposit because the deposit reductions, there's always a lag. So that has an impact. You expect a little bit of seasonality in our C&I business, albeit that activity has continued strong in the market during the summer. So that does bode well. So that's what supports our half 2. And inevitably, the structural hedge, obviously, is an underpin to all of that. So that's why we're comfortable to upgrade guidance, both on revenue and on returns at the half year. And then thinking beyond half 2 '24 out to '26, which is obviously, we have some targets out there. The structural hedge is a key part of that. And we'd expect loan demand to return and system-level deposits feel strong. So that's why we've talked about income growth -- feeling confident about income growth through '24 through to '26.

When you alluded to the structural hedge, I mean you upgraded your guidance for the hedge with 2Q boosting an already material tailwind for the business. How do you balance this, though, between the various stakeholders, shareholders, hitting the bottom line, the customer base or your ability to kind of compete for market share?

Well, on the hedge first, as you said, it's a healthy tailwind. We're seeing the benefits of that in '24. We also widened our disclosures in terms of what we expected the benefits to be in '25. We said GBP 800 million increase in '25 and more again in '26. So as you say, it's a healthy tailwind that supports the revenue profile, not just in the short term and out to the medium term. We're confident about that because it's very mechanistic. I know you understand this, you do a lot of analysis on it, but it's very mechanistic as we've locked in those benefits. That's why we're confident. The broader question of how you then think about it between the different stakeholders. Interesting enough, that's not -- I don't think about the different stakeholders in the context of the structural hedge. The way I think about it is the broader business. We're driving the business for returns. RoTE is our North Star. We want to drive capital generation and returns. And from that capital generation, I think about how we balance 3 things really, supporting our customers, investing in the business, but also returning capital to shareholders. So I don't think about that stakeholder question really through the lens of the structural hedge. I think about it through the overall performance of the business and making sure we've got the right balance between those 3. Those 3 name ways I can allocate capital. And if I do that right, if we as a business, do that right, that will drive long-term shareholder value. So that's how I think about it. I think it's quite -- it has different risks if you start to isolate different parts of the P&L and how you think about them for different stakeholders.

You mentioned rate cuts. The Bank of England delivered its first rate count in the first of August, markets are pricing in somewhere between 1 and 2 other cuts this year. How well positioned do you feel to navigate this rate-cutting cycle? And what do you expect the [ system ] to do around things that pass-throughs?

Yes. It's I guess it's the sector and ourselves, everybody has had a lot of time to prepare. I guess what was unclear is when the cuts would come, but at some point, they would come. So I think we've invested a lot of time over the last 18 months preparing some of the simple but very important things around the kind of practical operational processes, especially if you're going to have a [ fact ] potentially as you go into '25, maybe a succession of rate cuts. So we've invested a lot of time in that. But as importantly, and arguably more importantly, we spent a lot of time thinking about the product range over the last 18 months. We've widened the deposit range, both on the consumer side and on the commercial side. We're also very thoughtful around, for example, tiering within individual products. So I feel confident that we've done a lot of preparatory work ahead of rate cuts. We passed through, in line with our kind of sensitivity disclosures, circa 60% on the back of the first rate cut. I think the market response has been encouragingly rational. The majority of the kind of large incumbent banks have done something similar. So it's been a relatively immediate and relatively consistent reaction. Interestingly to me, some of the digital banks who are paying higher kind of rates have passed through a greater amount. So again, to me, that talks to kind of rationality in the deposit pricing. So I'm definitely encouraged by that. I think the system-level reaction overall, we're still early in the cycle. In our forecast, we have 1 more cut coming this year, 5 next year, I think 2 the year after. So another 200 basis points to go. My job is to balance kind of funding needs P&L competitive position. And I think we're well placed to be able to do that. But if you were taking your indicators from reaction so far, I think the responses have been very rational.

Great. So we've got some audience response questions. We'd love people in the room to kind of participate. You've got these devices in front of you. you can see the questions there. So what would cause you to become more positive on NatWest shares? One, better NII, two, stronger fees, better cost control, better asset quality, greater capital return, fixed reduction in U.K. government ownership?

All of the above there. Shall we?

Yes.

Interesting. We'll get on with that, I'm sure.

So it's kind of widely -- I mean, yes, so stronger fees, interesting, then interest income, then, I guess, U.K. government ownership. Let's shift to question 2. What are you most concerned about in NatWest? Weaker earnings, Weaker capital, lower distributions, reg risk, clinical risk, M&A.? Political risk, weaker earnings. I guess you're in control of only part of that. Why don't we do -- let's do the third question as well. Which is the biggest risk to NatWest, earnings, rate cuts, competition and cost inflation, loan losses, government intervention?

Interesting. Definitely a topic du jour. I'm sure we'll get on to it.

Exactly. Okay. We'll probably touch back on that subject a bit later on. Can you just talk about competition and a higher interest rate environment? Obviously, the operating environment has been turned upside down by higher interest rates. Profitability has swung to deposits and liquidity and away from traditional things like lending. I'm kind of interested in your assessment of the outlook for competition in this kind of new world, this new higher-for-longer world. And how do you navigate that strategically?

To me, there's some inevitability about what you say with the change in the rate cycle, there was obviously going to be, I guess, a change in the dynamics between I guess, the 2 sides of the balance sheet. So in many respects, kind of traditional and typical asset and liability management was kind of back to the fore and back to the center. So to me that was inevitable. And I think if you look at what NatWest has done over the last couple of years, the strength of the deposit base within the commercial franchise combined with thoughtful disciplined lending, which is profitable in its own right, has driven pretty healthy returns, circa 17% in '23, over 16% in the first half of this year. So given we're a broad-based bank, both from a customer segment perspective and a product perspective, seeing good asset and liability management has supported healthy capital generation and healthy returns. My response to that changing operating environment, the way I think about it is setting yourself up for now to drive good returns, but also setting yourself up for the future should that environment change, be it the competitive environment, but also it could be the rate environment. We have a view. Now what will happen -- but we all know that, that could be different. So that's the way I thought about the strategy in this operating environment. And we've been very consistent, and I think very clear about the 3 things that we're focused on. The first thing is disciplined growth. So we've been very thoughtful about where we want to grow. It's in the core of our business. It's not just lending-based growth, although we are pleased with the growth that we've driven in a couple of our asset portfolios, it's across a range of products. We've obviously grown organically, but we've also announced 2 small tuck-in acquisitions to help the growth on the inorganic side. So that's the first part of the strategy in this environment. The second part is simplification. I've been very focused on creating the investment capacity within the institution to be able to continue to invest in improving the business, driving a lot of simplification, automation, digitization, all the things that all of our stakeholders would expect us to do, but doing it within the existing cost envelope of the organization. And the reason why I believe that's important is if we get the first priority right in terms of disciplined growth, and we get the simplification agenda progressed, and that gives us the potential to create operating leverage irrespective of the environment that we head into. And then that's all underpinned by the third priority, which is a much more active approach to balance sheet capital and capital RWA management and liquidity management. And I think that strategy over the course of the last 12 months has pull-through. You can see that in the financial performance. You can see that in the customer metrics, which is great. But I am thinking about it not just -- yes, it's driving good healthy returns now. But it's also, I think, setting us up well irrespective of how that competitive environment develops or indeed, the economic cycle develops because I think what we'll have created is a bank that has the ability to grow. It can drive operating leverage because its marginal costs are reducing, and it's working its balance sheet a lot harder. So the classic managing today and tomorrow.

I mean you alluded to that in the answers around loan growth. It's been subdued in the U.K. in the face of higher interest rates, but you talk constructively about the growth prospects of your business. I'm interested in is that simply a case of kind of tracking system-level demand or is a scope for you to take market share?

So in my mind, it's both. And I think -- and I would say we don't just talk about it. We demonstrate it. That would be my view. We've demonstrated as the system recovers, be it mortgages, be it commercial lending, obviously, given our -- the scale of our market positions, the size of our customer base, we'd expect to benefit from that. But we've also demonstrated we can take a greater amount of market share in areas that are important to us and where we think we can drive the right returns. So the progress we've made in our mortgage business over the last couple of years, we've increased market share up to 12.5% from one going a fair way back of 6%, then it was 9%. So they're big -- these are big sums, our unsecured market share is increasing. You have seen our commercial lending business, excluding kind of COVID loans has grown by 3% as compared to a system level of 0.1%. So from my perspective, it's -- hopefully, there's a double benefit. We get system recovery, which supports demand but also we continue to take share. And what's encouraging to me about the share we've taken is we haven't done that by materially changing our risk appetite. We've done it in a disciplined way. We're very happy in the segments that we're deploying capital and the returns we get. So we drive the growth, but we keep the asset quality very strong, and that's a nice combination to returns and earnings. And I guess the complement to the organic activity is a couple of inorganic transactions. We've added a mortgage portfolio through our acquisition kind of 6, 8 weeks ago, we've added some nice market share within the same risk envelope to our unsecured book from our Sainsbury's acquisition. So we've got organic growth, but we're also complementing it with simple prime acquisitions.

You alluded also to the kind of risk appetite there. The broad observation is asset quality in the U.K. has been remarkably benign since a very long time. And this is not a new thing. I was looking at -- you've outperformed your cost of risk guidance for more than that for a decade. A notable exception was provision building during 2020, which everyone substantially wrote back. So it's not a new concept. And I think there is a view that U.K. banks perhaps aren't taking enough risk or under-risked businesses. So my question is, are you taking enough risk? Is there a chance for you to kind of dial-up your risk appetite here to kind of safely originate loans in this environment?

Yes. So the asset -- you're right, the asset quality performance continues to be very strong. We upgraded our guidance. I guess, to add to your kind of successive years. We upgraded our guidance at the half year, we said that cost of risk would be less than 15 basis points. In the first half of the year, it was -- it benefited some changes to our economic assumptions, but it is running at 3 to 4 basis points. So -- and we're seeing no signs of deterioration. So just to frame it, yes, asset quality is very strong. We're not seeing signs of deterioration. But to me, to link it to the previous question, but with the current risk appetite, we're still demonstrating we're able to grow in our chosen markets. We've listed them. So I would -- I'm very comfortable having a prime asset quality books, those that we're growing organically and those that we're buying inorganically. I think that gives the institution a very strong foundation, and I think it has served us well. I think the long sweep of 10-year trend or more, actually, kind of 12-year trend is the reality of the post crisis and the derisking that not just not NatWest has had to do, but the sectors have to do. So I think that explains that. The headline for me would be don't expect any fundamental change in our, what I would call, our risk posture or our risk positioning. We're very comfortable with the performance, very comfortable that we can grow with that risk appetite as all that risk posture. I think what often gets lost in the debate though is there's a big difference between moving up the risk curve and your risk posture to doing sensible things at a product level on an asset class level. And obviously, we review them all the time. So whether it's tweaks to mortgage policies, credit card policies, your SME lending, your private -- your kind of project finance lending, we're very active in that space. I think we have good antenna around risk-reward, and we'll make changes there where we see opportunities and where the risk-reward trade-offs are good. So you can expect to see that. But that's not a fundamental change in our risk cost. We're very comfortable with, I would say, the prime positioning that we have and the returns we can generate at that posture.

I want to turn to fees, if I could. So you generate close to 80% of revenues from net interest income, which is great, but also does leave you exposed to things like policy interest rates that are clearly outside of your control. So kind of what role does growing fees counter that? And more specifically, can you deliver on the kind of fee ambition organically? Or does it require outside inorganic acquisition?

So we start with revenue and income. You can see in the half 1 numbers, the quarter 2 on quarter 1 growth is about 5% on revenue. So that's -- we're pleased with that. If you drop down a level into the fee income, you can also see that actually, the growth was just below 5%, so relatively consistent. You're right, our business mix kind of drives a certain type of output and then creates a certain dependency on the wider policy environment. The growth that we've seen in our fee lines, whether it's payments, whether it's FX, whether it's assets under management on the private side is a function of the investment that we've been putting into those businesses. So we continue to invest in those businesses. We continue to be encouraged from the growth that we're seeing. The nature of our business mix, and I guess this is implicit in your question, the nature of our business mix, it means that it is very different to drive a step change in the revenue mix over a short period of time. That is the reality. Are we focused on fee income? Yes. Will we continue to invest in the products and the customer segments and the businesses to drive fee income? Absolutely. But the reality is given the math, it's going to take time to materially change that shift, which then triggers, I guess, the last part of your question around organic versus inorganic. We'll look at things. But I've been very public on we'll be very disciplined around, do they represent good shareholder value? Is it strategically congruent? And you look at what it would cost to buy fee income. And in the current environment, it looks very prohibitive to me. I don't think shareholders would thank me for some of the earnings multiples that are associated to the fee-type businesses relative to banking businesses. So I think the net-net of that is we'll work very hard organically to continue the growth. And the inorganic piece just feels very, very difficult to -- because of the costs associated with buying fee income.

Great. I might switch back to the ARS questions. We've got 3 more. Question four, what do you expect from NatWest revenues into '25? One, growing driven by NII; two, growing driven by fees; three, flat; four, falling driven by NII; five, falling driven by fees. Please take part. That's growing driven by net interest income. I don't know if you got a comment on that?

Yes. I mean I was clear at the half year around how we're thinking about revenue generally, not only for '24. As I've said, we increased our guidance, but also our confidence in the revenue line through into '25 and into '26, underpinned the structural hedge but also underpinned by growth. So I think that's a -- it's good people have listened. So I think it's a fair view of how we see things. And what I would add is a fair amount of those revenue benefits are locked in already. So that's why we've been I guess, public around our confidence levels around that.

Great. Let's go to question 5, please. What do you expect NatWest to do on capital and dividends versus market expectations? One, beat on better earnings; two, beat on lower capital requirements; three, miss, weaker earnings; four, miss on higher cap requirements; five, risk from inorganic acquisitions. Okay. It's pretty emphatic and constructive answer there: beat on better earnings volume growth. Let's do question 6 and then we'll kind of come back.

Obviously, I won't to comment on that one.

Question 6. So how are you concerned are you by the risk of U.K. bank taxes: one, I'm not concerned, I don't think it will happen; two, low concern, limited impact; three, moderately concerned; four, very concerned. Okay, [ three ], people are worried. I guess the 30th of October is...

Yes, I think the -- we have 6 weeks until the budget hits. What I would say is the sector already has to, in effect, bank taxes. We have the levy and we have the surcharge on corporate taxation. My personal view is the intent, which I generally believe it is from the new government, is to drive economic growth. Then what is absolutely required is a strong -- not just a strong banking sector, a strong financial services sector. And what will help with that strong sector is policy certainty as well as regulatory certainty. So that's how I think about it. And it will be good to get to the 30th to see what's in the budget. Where I want the capital of the bank to be consumed is supporting our customers, helping them grow, helping the U.K. grow. That's exactly how I think about it.

Great. Let's switch back to the business itself. So capital. You're highly capital-generative, but there are multiple draws on your capital. So you've got regulation. You've talked about an increase in RWAs. There's the growth out there, there's distributions, but there's also getting the U.K. government off the shareholder register, a journey that you guys are -- the end is in sight, interested in kind of how do you view the various priorities for allocating capital to your businesses?

As you maybe start with the capital generation itself. We are highly capital-generative, 140 basis points in the first half of the year. That allowed us to do the directed buyback of GBP 1.2 billion, to pay the interim dividend of GBP 500 million. We completed the previous buyback -- market buyback in July, and we've still printed 13.6%. So we have a business model that's working well and generating capital, which is great. The way I think about it is there's 3 components we talked about earlier. I guess the management discipline is to get the balance right between deploying that capital in support of your customers, number one. Number two, ensuring we're investing in the business to set it up for the future. We invest a lot in the business, over GBP 3 billion between '23 million and '25. 80% of that investment goes into technology and data, that's important. And then the third, which is the distribution to shareholders. We know how important that is. I know how important that is. I guess my management judgment is from the -- by being focused on returns, by generating these healthy levels of capital to get the balance right between those 3 areas. And then within distribution to shareholders, I've been very consistent. We start with the ordinary dividend, circa 40% of operating profit. We then look at directed buyback. We've executed one earlier this year, given the change in the U.K. listing rules, we have the potential, should the government want to do that, to do further directed buybacks. Then we look at our market buybacks. I still think with the stock trading where it is, there's value in that. And ultimately, whilst the DBB is in effect, a decision for the shareholder and the buybacks or a decision for the Board, we'll look at those options to distribute capital. So it's the balance between the 3.

In relation to the U.K. government then, I mean they're on course to exit, I think they're a shade below 17% at the moment. And at the current pace, I think it's a matter of months until U.K. government exits. What does it mean for NatWest? Does it free you up in any way strategically to kind of get the U.K. government out?

Yes. To me, the bank being back in private hands is in the interest of all of its stakeholders. So I think that's -- would be absolutely the best path. I've been really pleased with the reduction in the shareholding from what was 38% for the start of the year to just over 17%. So the trading plan is working well. We've executed the directed buyback. So that's great. And it will -- there's assuming market conditions are fine, that trading plan works really well. The strategic consequences, there's no direct strategic consequences. Ultimately, the strategy of the bank is set by management and the Board. The government shareholders never had a seat on the Board even going back to the financial crisis. So directly, there's no impact. But yes, I think the -- optically, completing the sell-down, returning the bank to private hands is absolutely in everybody's best interest. And I've been pleased with the messaging from the new government. They're committed to the sell-down during the '25, '26 fiscal year. So that's an encouraging message.

See if there's anyone in the room who wants to ask a question, we can just take a moment to -- yes, we've got one here.

First of all, thank you for coming all this way to speak with us today. My question really centers on the budget and the expectations around that, which I think, at least to an outsider, it sounds a bit like austerity 2.0, which really wasn't a good thing for the average U.K. citizen consumer. So are you concerned about the possibility that, that budget will change the dynamics in consumer borrowing that have been surprisingly favorable in the recent several years?

Yes. I think the easy answer is we'll need to wait and see because I think it is unclear exactly how the fiscal statement is going to play out. There is definitely fiscal constraints on the government. They're well known and they're well trailed. I think what they're trying to wrestle with is how to get that policy environment right to make sure that they can support growth but also be realistic around the state of the nation's finances. And at the moment, inevitably in a new administration ahead of their first fiscal statement, I think there's a lot of rhetoric, there's a lot of media coverage. I genuinely believe, and I think I said this earlier, I genuinely believe that the government wants to drive growth over the medium term. It wants to put policies in place that will facilitate that, whether that's investment, whether that's in skills and in productivity. I think they are clearly focused on the right things. They're trying, I think, to solve, in some respects, they're having to work through how they solve a short-term challenge, some of their near-term fiscal constraints, whether that's public sector pay, whether it's investments in health care. I think that's what they're working through at the moment. So to your question, am I worried? I'm very thoughtful about what the budget will contain. I'm not making any judgments at this stage about what will come on October 30. I do believe the government is trying to find the right balance. And we shouldn't forget that the consumer has managed through a very difficult environment. The reality is that most of consumers have managed to service their borrowing through a high rate environment. That's now coming down, consumer spending to a certain extent has held up. So there are some positive signals there, GDP, I touched on, has been higher than expected. So it's very much a watching brief, but I'm cautiously optimistic.

Cool. I think we're exactly on time. So I will thank everyone for joining us, and thank you very much to Paul for making yourself available. We'll bring it to an end there. Thank you.

Thanks, Aman.