Earnings Call Transcript - NWG Q1 2023

Operator, Operator

Good morning and welcome to the NatWest Group Q1 Results 2023 Management Presentation. Today's presentation will be hosted by CEO, Alison Rose; and CFO, Katie Murray. After the presentation, we will open up for questions. Allison, please go ahead.

Alison Rose, CEO

Good morning, and thank you for joining us today. I'll start with the business overview, and then Katie will talk about our financial performance. Our strategy continues to deliver against a backdrop of increased market volatility since we last spoke in February. In an uncertain environment, we're well-positioned based on the upside as we build on our strong customer franchise to drive targeted growth and for any downside as a result of our strong balance sheet and liquidity, high-quality deposit base and disciplined risk management. I'll start with the financial headlines. We delivered operating profit of £1.8 billion in the first quarter, an increase of 49% on the same period in 2022. Attributable profit was £1.3 billion, up 52% on the first quarter last year. Our return on tangible equity increased from 11.3% to 19.8%. And income grew 37% to £3.8 billion. Costs increased by £214 million, which includes the one-off payments we made to staff in January to help manage the rising cost of living. We continue to focus on tight cost discipline and are on track to achieve our 2023 cost guidance of around £7.6 billion. We told you at the full year that we expect to generate and return significant capital to shareholders this year and intend to maintain our 40% payout ratio. Our common equity Tier-1 ratio of 14.4% includes an accrual of just over £500 million for the full year ordinary dividend. We have also completed more than half of the £800 million on-market buyback announced in February. The government shareholding now stands at just over 41%, and we have regulatory permission to undertake a directed buyback, though any transaction remains at the government's discretion. Recent market volatility has had little impact on the bank and the average UK consumer. We have seen an expected reduction in deposits during the quarter. Customer tax payments have increased about £8 billion from the fourth quarter as more people fall into higher tax brackets. Customers also continue to pay down debt, including government lending. We are actively balancing value and volumes, taking into account customer behavior as well as competition in the market. Our funding is well-diversified and our loan-to-deposit ratio is 8%, resulting in surplus deposits of £53 billion. Our deposits amount to £422 billion across the three businesses, and our primary liquidity includes over £120 billion of cash. This gives us a liquidity coverage ratio of 139%, well in excess of minimum requirements with headroom of £43 billion. On the asset side, we have a well-diversified loan book where our top 10 wholesale customers account for around 5% of total loans. We have limited exposure to commercial real estate, which is less than 5% of the book with an average loan to value of 47%. 93% of personal lending is secured, and our retail mortgage book has prudent loan-to-value ratios with an average of 53%. Our book's performance demonstrates our strong risk management with low levels of arrears and impairment. Procyclicality remains at low levels and we continue to monitor this closely. The quality of our balance sheet and risk management enables us to continue to support our customers and the economy in these uncertain times. We are growing lending responsibly with an increase across our three business segments of £5.7 billion to almost £356 billion. Within this, we have seen strong growth in mortgage lending with flow share increasing from 15% to 17%. In Commercial and Institutional Banking, lending to large corporates grew £2.4 billion to £56.1 billion. We also continue to support entrepreneurs and small businesses which represent over half the UK economy. In March, for example, we issued our third social bond dedicated to women-led enterprises, the first of its kind from a European bank. Over the past three years, we have successfully delivered an organization that is more capital efficient, growing responsibly and increasingly easy for our customers to deal with. This enables us to shift the balance of our investment over the next three years and as we outlined in February, we will focus on growth: first, by increasing our engagement with customers at every stage in their lives; second, by supporting customers in their transition to a net-zero economy; and third, by embedding our services further in customers’ digital lives. Our purpose-led strategy and priorities remain unchanged so we will continue: to focus on creating a simpler organization that is highly cost efficient; to deploy our capital effectively in order to generate the best returns for shareholders; and to foster innovation and digital transformation to serve our customers better. I’d like to give you a brief update of how we are delivering on these priorities.

Katie Murray, CFO

Thank you, Alison. I'm going to talk about the performance in the first quarter using the fourth quarter as a comparator. Total income increased 4.5% to £3.9 billion. Income excluding all notable items was £3.8 billion, up 1.4%. Within this, net interest income was stable at £2.9 billion, and non-interest income was up 7.1% at £980 million. Operating expenses fell 7% to £2 billion, driven by the absence of the annual UK bank levy, partly offset by the one-off cost of living payment to staff in January. This delivers a cost-income ratio of 49.8% for the quarter. The impairment charge approximately halved to £70 million or 7 basis points of loans. Taking all of this together, we delivered operating profit before tax of £1.8 billion. Profit attributable to ordinary shareholders was £1.3 billion and return on tangible equity was 19.8%. I'll move on now to net interest income on slide 11. Net interest income, excluding notable items, was broadly stable at £2.9 billion. This was the result of two fewer days in the quarter, which offset the benefit from higher average lending volumes. Net interest margin, excluding notable items, increased 2 basis points to 327. Wider deposit margins added 12 basis points by reflecting the benefit of higher average interest rates, partly offset by lower average deposit balances, ongoing passthrough to savers, for which there is a timing lag and ongoing customer migration to higher interest-paying accounts. This was partly offset by lower lending margins, which reduced NIM by 9 basis points, driven by the mortgage front book. We continue to expect net interest margin for the full year of around 320 basis points. This assumes the current UK base rate remains at 4.25% throughout 2023, up from 4% in our previous projections, and the average reinvestment rate of our product structural hedge for the full year is 3.6%, up from 3.3%, which is largely offset by our expectation of lower average deposit balances. So let me turn now to deposits on slide 12. Customer deposits across our three businesses were £422 billion at the end of the first quarter, down 2.6% or £11 billion. This was mainly driven by tax payments, which were around £8 billion higher than the fourth quarter. This is a larger share of overall additional UK tax payments than our deposit share. We also saw increased competition for balances. Breaking this down by business, Retail Banking deposits reduced £4.4 billion driven by tax payments and higher customer spending. In Private Banking, the impact of tax was most pronounced given the customer demographic. We also saw continued reallocation of cash into investments. In Commercial & Institutional, deposits reduced £2.8 billion, mainly reflecting the reduction in system liquidity. Within Central & Other we saw a further £8.7 billion reduction. Half of this is the result of Ulster Bank customers’ migration to other banks, as expected, and it also includes normal Treasury activity.

Alison Rose, CEO

On deposits, flows. I mean clearly, what we've seen so far is nothing new idiosyncratic on deposits. We've got really strong franchises. I was very clear that we will manage our deposit base for value rather than chasing volume. That value is liquidity and income. We've got the right products to compete. I think in terms of what will happen with deposits, we've guided you to sort of stable to modestly down. It's going to be determined by customer behavior and some of the macro dynamics, you can see we've got a very robust LDR, and we're continuing to learn very well. So we're not seeing anything unusual in our deposits, broadly stable to modestly down. It's really going to be customer behavior and market competition, both of which we're very comfortable with.

Katie Murray, CFO

Alison Rose, CEO

Thank you, Katie. So to conclude, in an uncertain environment, our strategy continues to deliver. We are well positioned both for the upside as we build on our strong customer franchise to drive targeted growth and for any downside as a result of our strong balance sheet and liquidity, high-quality deposit base and disciplined risk management. We expect to return significant capital to shareholders this year with a payout ratio of 40% and capacity for additional buybacks. In the first quarter, we have already accrued just over £500 million for dividend payments and completed more than half of our £800 million on-market buyback. While Katie has summarized our guidance for 2023, over the medium term we plan to operate with a CET1 ratio of 13% to 14% and deliver a sustainable return on tangible equity of 14% to 16%. Thank you very much. And we'll now open it up for questions.

Operator, Operator

Our first question comes from Rohith Chandra-Rajan from Bank of America. Rohith, please go ahead.

Rohith Chandra-Rajan, Analyst

Hi everyone. Thank you. Good morning. Thank you very much. I just got one, please, on net interest income. So you slightly raised your interest rate assumptions but left the revenue guidance unchanged. The market is currently expecting rates to rise close to 5%. So, if that were to play out, I just wonder if you could talk through how that would impact your £14.8 billion revenue guidance, please?

Katie Murray, CFO

Yes, sure. Thanks so much. Thanks, Rohith. So if we really capped it, it all comes down to where we are on our interest rate sensitivity. And we continue to believe that we are interest rate sensitive. But importantly, the level of sensitivity has reduced due to a couple of things. First of all, a decrease in the surplus liquidity on the balance sheet. And you can see that through the reduction in our liquid asset and interest-earning assets on Slide 11, and also an increase in the incremental pass-through as base rates have gone higher. As we expected this, we've talked about this with you all a number of times. Our disclosure at the end of 2022 showed around £200 million of additional income for 25 basis points opposite in the yield curve. And remember, that in the effective balance sheet and a 50% pass-through, both of which were illustrative and not in reality the current experience. Our updated sensitivity based on the end of March balance sheet, assuming a 60% pass-through, would take that £200 million number and reduce it to £175 million of additional income. How the sensitivity develops going forward will be very much a function of changes in the balance sheet and competition. And I would just remind you, Rohith, all of this is baked into our income guidance of around £14.8 billion for 2023 and our 2023 medium-term royalty target of 14% to 16%, which we comfortably expect to be at the upper end of this year. Thanks, Rohith.

Rohith Chandra-Rajan, Analyst

Thank you.

Operator, Operator

Thank you. Our next question comes from Alvaro Serrano of Morgan Stanley. If you could please unmute and go ahead.

Alvaro Serrano, Analyst

Hi. Hopefully, you can hear me okay?

Alison Rose, CEO

Yes.

Alvaro Serrano, Analyst

I have two questions. The first is about your deposit structure hedging, and the second concerns mortgages. It seems like deposits may decrease somewhat this year, contrary to your earlier expectations of flat performance for the full year. Can you provide insight into your visibility regarding deposit flows for the remainder of the year and explain why you believe they will be more stable now? Additionally, could you update us on the structural hedge in Q1? Do you still anticipate a small reduction there? Moving on to mortgage spreads, you've clearly gained significant market share. I know you've addressed some reasons for this, but could you share your thoughts on the underwriting spreads and what you're observing early in Q2? Thank you.

Alison Rose, CEO

Great. Thank you. Well, look, I'll get Katie to go through that. On deposits, flows. I mean clearly, what we've seen so far is nothing new idiosyncratic on deposits. We've got really strong franchises. I was very clear that we will manage our deposit base for value rather than chasing volume. That value is liquidity and income. We've got the right products to compete. I think in terms of what will happen with deposits, we've guided you to sort of stable to modestly down. It's going to be determined by customer behavior and some of the macro dynamics, you can see we've got a very robust LDR, and we're continuing to learn very well. So we're not seeing anything unusual in our deposits, broadly stable to models to be down. It's really going to be customer behavior and market competition, both of which we're very comfortable with. Katie, do you want to pick up the hedge on the mortgages?

Katie Murray, CFO

Yes, sure, no problem. Thanks so much. So I'll start with the hedge Alvaro. So first of all, it's important to say no change in our mechanistic approach to the hedge. What we talked about when we spoke in March was around the product structural hedge notional was 184 billion, and we expected this to reduce by about 5 billion over 2023. We have around 40 billion of maturing balances, which come evenly over the year and they have an average yield of 1.1%. And at the moment, we're assuming an average reinvestment rate of 3.6%, so slightly up from when we spoke in February. At the end of Q1, the product notional hedge was £182 billion, so £2 billion lower, given the reduction in deposits in Q1 and the ongoing mix shift, we would expect that hedge to reduce a little bit further over the course of 2023. As a reminder, term deposits do not form part of the structural hedge. So the purpose of the product structural hedge is to reduce the sensitivity to changes in the short rate and smooth that income over five years. When I observe that the five-year swap rate is below SONIA, I believe that the impact on our 2023 income from not reinvesting maturing balances will be minimal. However, we do not simply rely on the interest rates for income. Our sensitivity mainly pertains to total deposit balances. We are currently investing at a higher rate of 3.6%, with a change in our average reinvestment rate of about 25 basis points. Regarding the sensitivity disclosure related to the structural hedge, we previously mentioned that we expect an income of £50 million in the first year, which remains largely unchanged given our investment rate. This year, if we consider our product hedge income of approximately £2 billion, which has been established since the beginning of the year, we are still on track with that figure around £2.4 billion and are comfortable with it. On the topic of mortgage debt, it has seen a 17% flow, which I mentioned earlier. In the first quarter, we were writing at around 80 basis points, a level we aim to maintain over time. There may be fluctuations each quarter depending on the swap curve and market pressures, but that's our target. We achieved that in Q1 and are pleased with that aspect, and the additional flow has been favorable, allowing us to support our customers when needed.

Alvaro Serrano, Analyst

So was that application or completion margin?

Katie Murray, CFO

That was a completion margin. So much higher than you would normally see just as a result of the actions we took in Q4 and then also in Q1, we saw people moving slightly faster from application to completion. I think as they were trying to make sure that they were assuring their ones. But I'm comfortable with 80 basis points. That's how we seek to manage the book, and we'll move on from there.

Aman Rakkar, Analyst

Hey, guys. Can you hear me?

Alison Rose, CEO

Yes, we can now. Yes.

Aman Rakkar, Analyst

Sorry. Sorry about that. Hey, good morning, Alison, good morning, Katie.

Alison Rose, CEO

Good morning.

Aman Rakkar, Analyst

I have a question about the deposit mix. Thank you for the slide on it. I have two questions regarding the deposit mix. What kind of mix have you factored into your revenue and NIM guidance for this year? I'm specifically considering 40% current accounts and 8% term deposits, and I know that number is increasing. Historically, those figures seem unusually high since we have often had much lower current accounts and significantly more term deposits. What are your assumptions, and what trends are you observing in terms of the mix shift now? Is this just a reaction to changes in base rates, or do you anticipate this trend to continue? Ultimately, where do you think these numbers will stabilize? What do you see as the long-term mix for your deposit base going forward, and how does it impact interest income? Thank you.

Katie Murray, CFO

Thanks, Alison. So I think, Aman, you're asking me the $50,000 question here in terms of that. I think a few things I would kind of point to as we kind of look at it. What's been really interesting is we haven't seen a particular move on interest-bearing to non-interest bearing. It stayed more or less around that 40% non-interest-bearing, 60% interest bearing. It might have moved up 1%. The next one has moved back there again. So it's pretty stable. So then you kind of look at the current account mix and go, well actually, it's not moving significantly. So that probably helps you on that piece. In terms of the term, we were at 6% at the end of Q4. We're up to 8%. That's across all of the businesses. And obviously, we introduced our own term account within retail. We've seen really good performance within there. I said that in March, it probably moved up another couple of percent. I don't expect that number to move that quickly in terms of that piece. But I would really kind of look to the ebbs and nib mix and then think about how much more term would be there. I think what will be interesting as we get later on in the year, what you'll see is the recycling of people's term accounts rather than more necessarily moving in as people come up to the kind of one-year kind of anniversaries in terms of that piece. But I think that kind of extended disclosure is probably the best guidance that we've got out there, and we'll see how that continues to evolve, and we'll continue to update you as we see that.

Aman Rakkar, Analyst

Is there any way you could tell us what you've assumed for this year in terms of that mix? It doesn't sound like you're assuming much more. Is that about right?

Alison Rose, CEO

We're not expecting any significant changes. It's really going to depend on customer behavior and how balances evolve. In the first quarter and what we observed in Q4, customers acted rationally, with some utilizing excess balances to pay down debt. Additionally, inflation is leading those with lower balances to spend more. These are the key macro dynamics, but there are no major shifts expected in the mix.

Katie Murray, CFO

Yes. Look, we're pretty relaxed about it in terms of LCR. Also, I'd look at our LCR. We have lower TFSME than others, our loan-to-deposit ratio is very strong. We have a lower LDR than the sum peers, which gives us capacity to grow. So we're very comfortable. So I'd look at it through a kind of mix and then our LDR.

Ed Firth, Analyst

Yes. Good morning, everybody.

Alison Rose, CEO

Good morning. Yes, we can hear you.

Ed Firth, Analyst

Thank you very much. I have two questions. The first is about capital. With your capital at 14.4, I wonder if you had proceeded with the directed buyback, which many anticipated, you would be around 13.6. I'm trying to assess your range, and it seems that there isn't much capacity for further buybacks beyond what you've already announced, unless you maintain enough for the directed buybacks. Is that reasoning generally correct? My second question is broader and is likely more for you, Alison. Currently, U.K. inflation is consistently exceeding expectations. From discussions with banks, it appears there are no signs of consumer stress, which makes me think that interest rates may need to rise significantly more than previously anticipated, as people are still spending and are banking on rates falling. Based on your observations, is my analysis generally accurate, or have you noticed any behavior among consumers that suggests they are beginning to feel the impact of higher interest rates? I apologize for the lengthy question, but I hope that made sense.

Alison Rose, CEO

I will do my best to answer. Regarding capital, we are generating it and our guidance range remains at 13% to 14%. We feel confident about the risk diversification within our portfolio and the overall strength we possess in capital generation. If the government chooses to proceed with a directed buyback, we believe that would also be a prudent use of our capital. Additionally, I have been clear about our commitment to distributing capital to shareholders. It’s important to emphasize the strong capital generation of our business. We are experiencing very low levels of impairment in our operations, indicating minimal distress across our portfolio. Our mortgage book has a loan-to-value ratio of 53%, with less than 5% in commercial real estate, averaging a loan-to-value ratio of 47%. We manage our portfolio effectively, which allows us to feel confident about our risk diversification. Our proactive engagement with customers has maintained low impairment levels, reflecting the resilience of both consumers and businesses we support. This risk discipline is crucial, and we are comfortable with the current low levels of impairment, along with signs of growing confidence. Our recent PMI data indicates an uptick in business confidence, which is encouraging. In terms of consumer behavior, we are observing rational adjustments in spending patterns. Although overall spending isn't increasing at the same rate as inflation, consumers are economizing and adapting to the inflationary environment.

Rohith Chandra-Rajan, Analyst

Hi everyone. Thank you. Good morning. Thank you very much.

Alison Rose, CEO

Great. Thank you.

Operator, Operator

Our first question comes from Rohith Chandra-Rajan from Bank of America.

Rohith Chandra-Rajan, Analyst

Hi everyone. Thank you.

Operator, Operator

Thank you. Those are all the questions we have time for. Apologies if we didn't reach you. The IR team will follow up with you afterwards. I will now hand back to Alison.

Alison Rose, CEO

Great. Well, look, thank you very much, everyone, for joining us and for taking the time with the questions. I think we're very happy with the Q1 results, a very strong performance in terms of right the way across the piece that we've deliberately positioned the bank and the balance sheet to have in an uncertain environment, both protection for any downside, but also well positioned for upside continued delivery of our strategy and strong customer franchises strong growth in Q1 as a result of that good diversification and liquidity that we have on our balance sheet and super disciplined risk management, which speaks to the level of impairments that we have there. So I think a good Q1, there's still uncertainty in the macro, but I think some positivity in terms of business confidence, and we look forward to catching up with you in Q2. But thanks very much for your time, everyone.