NatWest: Reducing Our Fair Value Estimate Slightly as We Expect Further NIM Pressure Over 2024

Equity Analyst

Niklas Kammer

Once the biggest bank in the world, NatWest Group is now a much smaller, mostly U.K.-focused bank with a good retail and commercial banking franchise. The bank also stands on a more solid footing than it has ever had during the last decade. The largest litigation and conduct issues—such as the residential mortgage-backed securities case in the U.S. and the redress for mis-sold payment protection insurance, which had been significant headwinds to performance over the recent past—have come to a close. 

NatWest has benefited from the rising interest rate environment. While mortgage margins remain under pressure due to the competitive nature of the U.K. mortgage market, higher deposit spreads have been a boon for NatWest. However, greater competition on deposits and a shift from current accounts into savings should offset some of the gains NatWest booked over the last two years. With the base rate likely to be cut some time in 2024, pressure on the net interest margin could intensify despite the hedging portfolio still forming a tailwind. All that said, we anticipate margins to remain well above levels seen during the close to zero percentage point base rate years of the recent past.

Business Strategy & Outlook

We do not assign a moat to NatWest. Although we believe its retail and small business banking operation benefits from a cost advantage through a large retail deposit base, we view the government's shareholding as a deterrant from awarding a moat. Natwest has addressed many of its shortcomings and restructured its business toward the more moaty U.K. franchise over the recent past, which we view as positive overall. However, we don't believe it currently warrants a narrow moat rating.

The U.K. government remains the majority shareholder in NatWest (stake 38%), which does not contribute positively toward our moat assessment. Even though the government participation is silent in principal, anti-bank sentiment in the public could potentially affect NatWest more than peers as a result. On the other hand, we don’t see the government stake as a detrimental factor keeping NatWest from earning a moat in the future. The government’s clear intention is to liquidate the position, preferably at a profit. As such, we believe that should NatWest get into moaty territory, which would be reflected in above cost of capital returns in the future, the government would float all its shares and therefore resolve this issue. Nevertheless, its government participation remains a significant hurdle toward an affirmative moat rating for NatWest. 

Core and center to our moat methodology for banks is our view of the regulatory and competitive environment in which a bank operates. Our assessments range from Poor to Very Good, lowering or increasing the hurdle we think a bank needs to overcome to gain a moat. We see the regulatory environment as fair and note that it has improved significantly since the global financial crisis. Poor oversight was a key factor in U.K. banks' poor performance during the crisis. Anti-bank sentiment remains in the U.K., and banking regulation, partially as a result, changes frequently and is more onerous than elsewhere in Europe. We think that the higher cost of operating in the U.K. system, such as the bank tax and levy, will make it more difficult for U.K. banks to outearn their costs of equity over time. Additionally, regulatory changes such as ring-fencing requirements--the separation of U.K. retail from investment banking--increase pricing competition in retail lending and have been costly to implement for U.K. banks.

We think the competitive environment in U.K. for banks is good. The U.K. banking market is dominated by five high street banks (Lloyds, NatWest, Barclays, HSBC U.K., and Santander U.K.) controlling about 60% of gross lending assets. We think this constitutes a comfortable oligopoly, allowing the largest banks in the system to realize scale effects and reap the rewards from a high share of cheap and sticky deposit funding. Indeed, we find that to a varying degree all five high street banks benefit from this market segmentation. While this does not result in a moat by default, we do think the good competitive environment in the U.K. is a supportive factor in a bank’s ability to carve out a moat. 

On a stand-alone basis, NatWest's retail and small-business banking operation could warrant a narrow moat rating. As one of the five high street banks in the consolidated U.K. market, we believe NatWest enjoys cost advantages in the form of a sizable deposit base establishing a low cost and sticky funding source. We typically assign moat ratings for retail and commercial operations based on access to a large pool of deposit funding, particularly non-interest-bearing checking accounts, which form one of the cheapest types of funding a bank can obtain. The strength of a moat based on this potential funding advantage is enhanced if we find switching costs that prevent clients from moving this inexpensive source of funding to competitors in search of higher rates. Preferably, the deposit base consists mostly of retail rather than wholesale deposits, as the former tend to be stickier and lower cost compared with the latter.

None

Economic Moat

NatWest Group plc 

NatWest Group Plc engages in the provision of international banking and financial services. It operates through the following segments: Personal and Business Banking, Commercial and Private Banking, RBS International (RBSI), NatWest Markets, and Central Items and Other. The Personal and Business Banking segment consists of the United Kingdom Personal, Business Banking, and Ulster Bank RoI sub-segments. The Commercial and Private Banking segment covers the Commercial Banking, Private Banking, and RBS International Commercial Banking sub-segments, involved in serving retail, commercial, corporate, and financial institution customers. The RBSI serves retail, commercial, corporate and financial institution customers in Jersey, Guernsey, Isle of Man and Gibraltar and financial institution customers in Luxembourg and London. The NatWest Markets offers corporate and institutional customers global market access, providing them with trading, risk management, and financing solutions. The Central Items and Other segment include corporate functions, such as RBS treasury, finance, risk management, compliance, legal, communications, and human resources. The company was founded on March 25, 1968 and is headquartered in Edinburgh, the United Kingdom.

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NatWest Group Plc engages in the provision of international banking and financial services. It operates through the following segments: Retail Banking, Private Banking, Commercial and Institutional, and Central Items and Other. The Retail Banking segment provides a comprehensive range of banking products and related financial services including current accounts, mortgages, personal unsecured lending, and personal deposits. The Private Banking segment focuses on the private banking and wealth management services to UK-connected high-net-worth individuals. The Commercial and Institutional segment includes expertise and tailored solutions needed by businesses, from entrepreneurs through to large corporate organizations. The Central Items and Other segment refer to the corporate functions, such as treasury, finance, risk management, compliance, legal, communications and human resources. The company was founded on March 25, 1968 and is headquartered in Edinburgh, the United Kingdom.

British high street lender NatWest Group PLC reported flat quarterly profits on Friday, as bad loan charges from a worsening economic outlook took the shine off income boosted by rising interest rates. NatWest posted pre-tax profit of £1.1 billion for July-September, slightly below the £1.2 billion pounds average of analyst forecasts compiled by the bank, and unchanged on the prior year.

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News for NatWest Group plc Stock (NWG)