NatWest Group PLC (NWG) 2023 Q4 法說會逐字稿

Good afternoon, and welcome to the NatWest Group Q1 Results 2023 Fixed Income Call. Today's presentation will be hosted by CFO, Katie Murray; and Treasurer, Donal Quaid. (Operator Instructions) Katie, please go ahead.

Good afternoon, everyone. Thank you for joining our full year 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 headlines for 2023 before moving on to some of the financials for the fourth quarter. Donal will take you through the balance sheet, capital and liquidity, and then we'll open up for questions.

Starting with the full year performance on Slide 3. Income, excluding all notable items, was GBP 14.3 billion, up 9.8% and in line with our guidance we gave last quarter. Operating expenses rose 4% to GBP 8 billion, including GBP 7.6 billion of other operating expenses. Together, this contributed to taking our cost-to-income ratio below 52%. The impairment charge was GBP 578 million or 15 basis points of loans, in line with our guidance.

Taking all of this together, we delivered operating profit before tax of GBP 6.2 billion. Profit attributable to ordinary shareholders was GBP 4.4 billion and return on tangible equity was 17.8%.

Today, we announced a final dividend of 11.5p, bringing the total dividend for the year to 17p.

Turning to Slide 4. We have set our business priorities for 2024, that Paul covered in the equity call this morning. Our focus is on creating sustainable long-term value, and we have 3 key priorities, all focused on driving returns. Our first priority is to continue to grow our 3 franchises in a disciplined way, building on strong market positions, targeting growth in areas of attractive returns.

Our second priority is to drive bank-wide simplification to make it easier for our customers to do business with us, improve productivity, and drive significant efficiencies and operating leverage.

Our third priority is to deploy capital efficiently and maintain strong risk management in order to drive capital generation. So as you can see, we are very focused on levers we can control, but the macro environment, driven by the expected reduction in interest rates and continuing changes in customer behavior, which I will cover in more detail later, means that we are adjusting our target for return on tangible equity. We now expect to deliver RoTE greater than 13% in 2026, while operating with a CET1 ratio in the range of 13% to 14%.

Turning to the fourth quarter on Slide 5, using the third quarter as a comparator. Income, excluding all notable items, was GBP 3.4 billion, down 2%. Operating expenses were GBP 2.2 billion, including the annual U.K. Bank levy.

The impairment charge decreased to GBP 126 million or 13 basis points of loans. And profit attributable to ordinary shareholders was GBP 1.2 billion.

Turning now to our 2023 income performance on Slide 6. Full year income, excluding all notable items, was GBP 14.3 billion, and bank net interest margin was 304 basis points. Net interest income was 12.1% higher, benefiting from a favorable yield curve movements, partially offset by the change in deposit volume and mix. Noninterest income, excluding notable items, grew 2.5%, supported by increased customer activity and higher income from the Markets business.

Turning to the fourth quarter. Underlying net interest income was GBP 2.7 billion, broadly stable versus the third quarter. Noninteresting income was 6.9%, reflecting seasonally lower trading and other income. Bank net interest margin reduced by 8 basis points to 286 basis points, which includes a 3 basis point drag from notable items. As expected, the rate of margin compression was slower than in the third quarter.

Going forward, we will report group net interest margin, which presents statutory group net interest income as a proportion of all average interest-earning assets. Full year group net interest margin increased 31 basis points year-on-year to 212 basis points as a result of higher deposit margins net of pass-through and mix changes and lower mortgage margins.

I'd now like to talk about our income outlook for 2024 on Slide 7. As we think about income into 2024, interest rate changes, associated pass-through and the second order impacts on customer behavior are the key considerations, and they remain difficult to predict. To summarize, the 4 income drivers today are, first, our plan assumes the Bank of England will start to reduce interest rates from May, reaching 4% by the end of 2024. We assume that this will be reasonably spread out and in 25 basis point increments. The actual outcome may, of course, be different. We expect to pass through changes to interest rates to our customer deposit rates but the quantum and timing is subject to competition as well as contractual terms and conditions.

The second driver is deposit volumes and mix. Overall, we expect deposit balances to follow a similar pattern to 2023, reducing in the first quarter due to annual tax payments and then some recovery after that, subject, of course, to market dynamics. We anticipate less change in deposit mix than we experienced in 2023.

Third, we expect the hedge to deliver a tailwind in 2024 despite a reducing hedge notional and for the strength of this tailwind to increase into 2025 and 2026 as volumes stabilize.

Finally, on the asset side, we experienced significant mortgage margin pressure in 2023 as our mortgage customers refinanced onto higher rates at a tighter margin. This headwind continues to moderate, and we expect the mortgage book to stabilize around the middle of 2024, although this is dependent on market dynamics. Taking all of this together, we expect 2024 income, excluding notable items, to be in the range of GBP 13 million to GBP 13.5 billion.

Turning now to costs on Slide 8. Other operating expenses were GBP 7.6 billion for 2023, in line with our guidance. That's up 4.6% on the prior year mainly due to staff costs, including the average annual wage increase of 6.4% and a one-off payment in January this last year to support colleagues with the rising cost of living. In 2024, we expect to hold other operating expenses broadly stable. In order to keep costs broadly stable from here, we will continue our strong track record of mitigating inflation by making cost savings.

Turning to the asset side of the balance sheet on Slide 9. We are pleased to have delivered another year of balanced lending growth across the group. Gross loans to customers across our 3 businesses increased 2.6% or GBP 9.1 billion to GBP 359 billion. During the first half, we delivered strong mortgage growth, whereas in the second half, we delivered strong corporate loan growth as we took a disciplined approach to capital allocation in a competitive and dynamic market.

During the fourth quarter, customer loans across our 3 businesses increased by GBP 1.1 billion. Taking retail banking together with private banking, mortgage balances reduced by GBP 500 million as customer repayments offset new lending. Mortgage flow share for the full year was 14%, reducing to 10.5% in the fourth quarter as we manage the balance sheet in a smaller, more competitive market. Our stock share increased from 12.3% at the start of the year to 12.7% at the end.

Unsecured balances increased by a further GBP 300 million in the quarter, to $15.8 billion, reflecting strong demand for credit cards.

In Commercial & Institutional, gross customer loans increased by GBP 1.4 billion. Within this, the Corporate & Institutional segment increased $2.2 billion, partly offset by companies continuing to pay down government scheme borrowing.

Turning to our loan book composition on Slide 10. We have a well-diversified prime loan book that is performing well. Over half of our group lending consists of mortgages with an average loan to value of 55% and around 70% on new business. We monitor the impact of higher rates on customers closely after they refinance and whilst arrears have increased slightly, they still remain low.

Our personal unsecured lending is less than 4% of group lending, and is performing in line with expectations with good quality new business. Across our wholesale portfolios, our corporate book and other exposures such as commercial real estate remain well diversified and are still performing well. And we are not in scope for the FCA review into motor finance.

Moving to impairments and our economic assumptions on Slide 11. We have reviewed and updated our economic scenarios, including forecasts and relative weightings. Our weighted average expectations for GDP are slightly improved in 2024 with a small decline in 2025. We also anticipate a slight deterioration in levels of employment in both 2024 and 2025.

Our balance sheet provision for expected credit loss includes GBP 429 million of post-model adjustments for economic uncertainty. We remain comfortable with 93 basis points as coverage of the book, which continues to perform well. We reported a net impairment charge of GBP 578 million for the full year, equivalent to 15 basis points of loans. The current performance of the book, combined with our updated economic outlook means we are expecting a loan impairment rate below 20 basis points in 2024.

And so turning to guidance on my final slide. In 2024, we expect income, excluding notable items, to be in the range of GBP 13 billion to GBP 13.5 billion and group operating expenses, excluding litigation and conduct to be broadly stable versus 2023, and the lower impairment rate to be below 20 basis points, delivering a return on tangible equity of around 12%.

And to remind you, in 2026, we expect to deliver a RoTE greater than 13% whilst operating with a CET1 ratio in the range of 13% to 14%. We are committed to delivering value for shareholders, and so we maintain our payout ratio of around 40% for ordinary dividends with the capacity for buybacks. And with that, I'll hand over to Donal.

Thanks, Katie. Good afternoon, and thank you for joining today's call. I'll start by sharing some highlights for the full year before moving into more detail on the balance sheet, covering deposits, liquidity and capital. I will then give guidance on our funding plans for the year ahead.

Starting with the highlights on Slide 14. We ended the year with a strong capital, MREL and leverage position, comfortably above the regulatory minima with a CET1 ratio of 13.4%, a total capital ratio of 18.4%, a leverage ratio of 5% and a total MREL ratio of 30.5%. The group's funding is well diversified with a strong retail, private and corporate deposit franchise as we ended the year with GBP 419 billion of customer deposits. Our liquidity coverage ratio was 144%, giving us comfortable surplus above minimum requirements.

Our loan-to-deposit ratio was 84%, and our net stable funding ratio was 133%. It was pleasing to see further progress on our credit ratings in April, with S&P upgrading all NatWest Group entities, recognizing the group's financial performance, robust balance sheet and solid funding and liquidity.

The 2023 Bank of England stress test once again highlighted NatWest Group's robust balance sheet, given the significant derisking completed over the last 10 years, providing further confidence that we are well able to withstand a severe shock and enabling us to support our customers and the U.K. economy.

And finally, last year, we successfully completed our funding plan with GBP 4.6 billion of issuance from the holding company across both senior MREL and Tier 2 and GBP 2.4 billion from our operating company, NatWest Markets. Thank you for the continued support for NatWest Group and NatWest Markets transactions.

Turning to liquidity on Slide 15. Our liquidity position remains strong with an LCR ratio of 144% at the end of Q4, reflecting around GBP 45 billion of surplus primary liquidity above minimum requirements. We manage a high-quality liquid asset pool. Our total liquidity portfolio was $223 billion, comprising primary liquidity of GBP 148 billion and secondary liquidity of GBP 75 billion.

Cash deposits with central banks represents 67% of total primary liquidity. The remaining 33% mostly comprises highly rated Level 1 LCR securities with a smaller percentage of Level 2 LCR securities. The majority of our liquidity portfolio securities are held on the balance sheet at fair value.

Looking at our customer deposits on Slide 16. We operate with a diverse deposit franchise with a mix of retail, private and commercial deposits across interest-bearing and noninterest-bearing product offerings. Customer deposits across our 3 core businesses were $419 billion at the end of the year, resulting in a loan-to-deposit ratio of 84%.

In the fourth quarter, we saw a reduction in Commercial & Institutional balances of around $8 billion, driven by outflows from our larger corporate and institutional customers as we actively manage low margin, low liquidity value deposits, in addition to normal year-end flows.

Across retail and private deposits grew by GBP 4 billion in the quarter, mainly in term accounts. Noninterest-bearing balances were 34% of the total, down from 40% at the start of the year. And customers continue to move balances to fixed term accounts, but at a much slower pace than we saw in Q3. Fixed term balances now represent 16% of our deposit mix, up from 6% at the start of the year. We remain very focused on proactively managing our deposit base with uncertainty on both the timing and magnitude of U.K. base rate cuts that will continue to impact customer behavior.

Turning to our capital and leverage position on Slide 17. Our CET1 ratio at the end of the year was 13.4%, within our target range of 13% to 14%. We operate with 290 basis points of headroom above the maximum distributable amount of 10.5%, which increased during 2023 as a result of the U.K. countercyclical buffer moving to 2%. Our U.K. leverage ratio decreased by 40 basis points to 5%, leaving around 115 basis points of headroom above the Bank of England minimum requirements. The decrease was due to an increase in lending across our retail and commercial businesses and a reduction in core equity Tier 1 from shareholder distributions and share buybacks as we moved to within our target range of 13% to 14%.

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 ratio requirements or combined buffer requirements for NatWest Group, it is included in our minimum supervisory requirements.

Looking at the drivers of the CET1 ratio on Slide 18. In 2023, we generated 154 basis points of capital before the impact of nonrecurring notable items and RWA model updates. This net capital generation was offset by distributions to shareholders equivalent to 195 basis points. Risk-weighted assets increased by GBP 6.9 billion in the year to GBP 183 billion, primarily driven by increases in credit risk exposures in commercial and institutional and retail banking.

GBP 3 billion was due to model updates and operational risk RWAs were GBP 1.1 billion higher following the annual recalibration. These increases are partially offset by a GBP 4 billion reduction relating to the phased withdrawal from the Republic of Ireland. Our exit from the Republic of Ireland is now largely complete, and we received dividends of EUR 1.1 billion from UBI DAC including a EUR 300 million in the fourth quarter.

We continue to expect risk-weighted assets to be around GBP 200 billion at the end of 2025, including the impact of Basel 3.1 and further CRD4 model developments. This is subject to final rules on credit and output floors, which we expect later this year.

Turning to our capital and MREL position on Slide 19. Our total capital ratio for the year is 18.4%. Given our CET1 target range of 13% to 14%, we expect to continue operating with optimal levels of AT1 and Tier 2 capital relative to our minimum requirements. We currently have an AT1 ratio of 2.1% with GBP 3.9 billion of securities outstanding. Two of these securities with a total nominal of $2.65 billion of their first call in 2025.

Our Tier 2 ratio is 2.9% with GBP 5.3 billion of securities outstanding. Our total MREL continues to look healthy at 30.5%, significantly higher than our risk-weighted asset requirement.

Turning to our 2024 funding requirements on Slide 20. From NatWest Group, we expect our senior MREL issuance to be in the range of GBP 4 billion to GBP 5 billion this year, primarily to refinance maturing securities. On capital, we plan to be active in both Tier 2 and AT1 this year. On Tier 2, we expect to issue between GBP 1 billion to GBP 2 billion. On AT1, we are guiding up to GBP 1 billion of issuance this year, providing flexibility for both forecast increases in risk-weighted assets and looking ahead to our 2 upcoming calls next year. Actual issuance, as always, will be subject to both the evolution of risk-weighted assets and market conditions.

In support of our funding requirements, we plan to be active in dollar, sterling, euro and yen markets from our holding company. From our operating company, NatWest Markets will have senior unsecured funding requirements of GBP 3 billion to GBP 5 billion in 2024, primarily to refinance maturing legacy debt, of which we have already issued EUR 2.5 billion in January in a dual tranche transaction.

And finally, we will also consider a covered bond transaction of up to GBP 1 billion from NatWest Bank, given the upcoming maturity in May this year of our last remaining outstanding covered bond under this program.

With that, I'll hand back to Katie.

Thank you, Donal. So to conclude, our priority is to continue supporting our customers in an uncertain macroeconomic environments. We are pursuing opportunities for targeted growth across our business with a focus on returns as we strike a balance between volume and margin. By combining this disciplined approach to growth with tight cost control and efficient capital allocation, we plan to drive strong capital generation so that we can both reinvest in the business and continue making attractive distributions to shareholders with a payout ratio of around 40% and capacity for buybacks, we remain fully committed to creating sustainable long-term value for shareholders.

And with that, we'll open the call for questions.

(Operator Instructions) Our first question is a pre-submitted question.

Can you talk through your timing expectations on AT1 issuance this year?

Donal, do you want to take that?

Yes. Happy to take that. So on AT1, what we said is the guidance is for up to GBP 1 billion primarily for 2 reasons. As I said, good flexibility on the trajectory of risk-weighted assets over the next 12 to 24 months. You know our guidance is $200 billion of risk-weighted assets by the end of 2025.

And then secondly, to give some thought to our upcoming AT1 calls. We start thinking about that 12 months in advance. So our first call is August '25 of next year. That's the 8% with a nominal of $1.15 billion. So I think I'd be very, very (inaudible). It's up to GBP 1 billion. If market conditions are conducive, it's something we will consider, most likely in the second half of the year.

Our next question comes from Robert Smalley of UBS.

Two questions. First, on loan loss provision. You delivered on a very low loan loss provision for 2023. The number is only up slightly in the guidance for 2024. Other than some tweaks in the macro outlook, are there any other changing themes behind that, even though we come up to the same place, roughly?

And my second question is on deposits. As we grow market share in deposits, how are you judging the quality of the marginal deposits that you're getting? And by that, I mean do you look at it in terms of deployment opportunity or how many products this depositor uses across the system? I'm sure it's a mix, but could you rank your priorities for us?

Yes. Sure. I'll take the first one, and then Donal can jump in on the deposit piece. So if you look at our impairments, 15 basis points this year, less than 20 for next year. I mean really kind of very stable in terms of how they're looking. There's been a few kind of dynamics going on. I think one of the interesting things is around what we've done with the PMA. If I look at the PMA last year-end, it was at 411. And actually, this year, it's a little bit higher at 500. So there will be a little bit of a feature, I suspect, of some unwind next year. We've always said that we'll be very cautious on that. .

Though in reality, that would bring your number back rather than kind of have it increased slightly. So there's no change in methodology. But I do think the unwind of that PMA will be interesting. Earlier this year, with all of the cost of living issues, we had increased it a little bit. And I think as we -- as our economics have improved a little, we'll wait to see how things evolve during the quarter -- through the quarter, so you will see a bit of that. But other than that, the methodology is as it has always been. Donal?

Yes, it's a good question, Robert, on the margin value of deposits. I think there's a number of different factors as you laid out. I think probably the 2 key ones for me is liquidity value and then the stability of that deposit from a liquidity value perspective. So I think it is all quite linked back to our, I suppose, the importance of our customer in promising relationships across not just retail, but our corporate and private business as well. But yes, liquidity and stability value would be key.

Our next question comes from Sharada Patel of Citi.

So my first question would be around asset quality, similar to the previous question, but just digging into the underlying cost of risk and particularly on the corporate loan book. So what kind of indicators are you looking at? And what's your thoughts for 2024?

And then my second question would be around the LCR and what you kind of think is your correct steady-state level of LCR, and obviously related to that, your liquid assets as we look ahead into 2024 and beyond?

Yes, sure. Thanks very much. So look, as we look at the indicators, I mean, within the corporate book, we obviously have this concept of kind of heightened monitoring, and then we look at -- and then as -- people go into heightened monitoring is where we kind of give them more attention within our restructuring units. And then ultimately, whether they crystallize as kind of a risk of credit loss. And there's quite some good -- we give you in the accounts in that section, really quite a lot of good information.

You can see the details of how we run that, that piece within there. But it's very much working with the customers, seeing where they're having problems, seeing whether they -- we should approach them about their issues in terms of their flows, seeing their accounts to whether -- many of them will come to us automatically.

If I look at the impairment losses that we had this year, it was GBP 94 million for the year in commercial institutional, down from last year at GBP 122 million. I'm not going to break down the less than 20 bps into kind of segment by segment. But what those levels of numbers tell you is that they are incredibly low for commercial and institutional business. So there's kind of -- we've heard the real absence of kind of what we called tall trees or some kind of single name losses. That's because a lot of the derisking we've done through the book over the years, but it's also because of the real health and quality of the book as they continue to work their way through the kind of economic turbulence. And given that we see economics improve a little bit, they will definitely be part of our impairment narrative next year, but they come from a very strong position.

Donal, LCR?

Yes, LCR, I think it's very, very hard to say what a steady state is because we're happy to run on higher LCR if it's made up of high policy liquid deposits that add income value as well. And I suppose when we look across, again, similar to the last question across our 3 core franchises that we continue to grow our deposit base there in an income-generative manner. I'm very, very happy to run an LCR -- a higher LCR on the back of that.

We have said kind of historically, we'd always look to run an LCR above kind of 130%, that's a very rough guide, and I would probably stick to that. I think one thing to remember is probably upcoming TFSME refinancing requirement. So at the moment, a number of -- I'm probably afraid to say our LCR ratios are inflated by our TFSME drawings. For us, it's a small component, GBP 12 billion, about GBP 4 billion of that's repaid at the end of 2025 with the remaining elements about GBP 8 billion in Q1 '27.

And then in terms of trajectory of liquid assets, I think that will primarily be a function of movements in our deposit base over the next year or 2. But yes, it's probably -- you know what, I think above 130 LCR is probably a good level to think of.

Our next question was pre-submitted.

Could you elaborate on what is driving expected income decrease in 2024? Is a large fall from the GBP 14.3 billion you've just reported for 2023?

Yes. Sure, absolutely, and thanks very much for the question. I guess the way that I think about it is there's 4 main things that you should keep in mind about that. The first, clearly the most impactful is the base rate reductions and then the associated pass-through that we have on deposits as those reductions come through.

In our numbers, we've assumed 5 base rates starting in May and a further 4 cuts coming through in 2025. Clearly, the timing of rates may be different from what we are imagining, but certainly, that's been one of the drivers of that move from where we are now to the 13 to 13.5.

Secondly, deposit volumes and mix. We do expect deposit volumes to fall a little in Q1 as a result of the tax payments and thereafter, move broadly in line with the market.

Third, the structural hedge. As deposits stabilize in the middle of the year, we do start to see the structural hedge adds kind of more income into the second half of the year, so -- and a very good kind of yields, although the absolute size of the hedge will fall, given the yield differential that's coming on, we'll expect that to be quite valuable in 2024 and really growing in value as we move into '25 and '26.

And then finally, the last thing, mortgage volume and margin. We do expect the book margin to stabilize in the middle of 2024. We talked about it getting to 80 basis points by the end of the year, and that's where we've landed. We're now writing at around 70 bps. So there'll be a bit of movement, but it's not as significant as we've seen in the past. But overall, expecting the shape of income to improve as we go through the year with the second half stronger than the first overall.

Our next question is your MREL ratio has come down steadily. I think from 36% to 37% to 30.5% today. Is 30.5% your steady state given your minimum requirements?

Happy to take that one Katie, I think they're there about around [30%] feels about right. The key driver of that reduction over the last few years has really been our -- the reduction in our CET1 ratio. And given now that we're kind of operating within our 13% to 14% range, 13.4% at year-end. I think that 30% total MREL ratio is a good guide, as I look forward.

Our next question comes from Phil at Decker.

Appears we might have a problem with Phil's microphone at the moment. So we'll hopefully come back to you, Phil.

Our next question is, is your guidance for covered bonds driven by the upcoming TFSME repayments?

I'll take that one, Katie. No, it's probably fair to say. So in terms of covered bonds, again, we've guided to up to GBP 1 billion. The way I look at that is we only have one covered bond outstanding under our existing program. So this time last year, we had 3 outstanding. We've had 2 maturities in the last 12 months, the last bond outstanding matures in May of this year. And I think we're quite conscious of the fact that our covered bond and investor base is different to our investor base from a holdco and opco perspective as well. And it is, I think 2019, since we last issued a covered bond to really to keep that program live, as I look ahead in 2024.

I now like to hand back to Katie for any closing comments.

Super. Thanks very much indeed, and thanks very much for your involvement today and obviously for your continuing support as we continue to issue what is a well-received program. We look forward to talking and meeting with many of you over the next coming months. Thanks very much, and I think we'll speak again formally in July.

That concludes today's presentation. Thank you for your participation. You may now disconnect.