Description

In 2020 RBS was rebranded NatWest, due to RBS’ association with the financial crisis and affiliated horrors.  What remains is a retail and C&I lender with a small investment bank.  In 2008 the UK government recapitalized RBS and took a 60% stake, which the government has recently sold down to below 50%.  NatWest trades for .85x tangible book value, a premium to large peers (.7x), but has more sensitivity to interest rates than peers coming off of all time low NIMs.

NatWest is better reserved than its peers despite having better credit performance.

NatWest’s portfolio average mortgage LTV is 53%.  Barclays is at 51% and Lloyd’s at 40%.

While being better-reserved, NatWest maintains a semi ok CET1 ratio.

The UK banks maintain a very low loan to deposit ratio, so they have tremendous liquidity and balance sheet capacity.

On a Q2 run-rate basis, adjusting the Q2 provision up to an across the cycle provision rate, I estimate that NatWest is earning £.38/share and trades for 7x forward EPS.  This EPS number does not include the benefit of two BOE rate increases since the end of Q2.  Year to date NatWest has experienced a .15 deposit beta, though this is expected to increase.  It also doesn’t include the benefit of a cost savings program which is heavily backend loaded toward the 2H.

At the Q2 report NatWest upgraded its income outlook significantly.  The ROE outlook was raised from above 10% to 14-16% for 2022.  Not many companies are increasing their already very decent profit outlook by 40% in 2022.  So that’s nice.

Barclays reports that July card spend grew 7.7%, likely contractionary on a real basis as CPI was probably in the 9-10% vicinity.  Is it a recession?  Who’s to say.  Will homeowners default on their fixed mortgage payment because their nominal salaries are only up 5%?  Probably not.  Corporate earnings probably deteriorate where costs are up more than revenue, but perhaps to a lesser extent than in a deflation.  At any rate, I believe that inflation was always going to be transitory, just not on the time scale of markets.

I believe NatWest has the ability to buy back 30% of shares outstanding over the next two years.  Even if NII settles around the Q2 run-rate, and provisions normalize to across the cycle levels, NatWest could be earning about £.50/share in two years.  At a 12x EPS multiple, the stock could be worth about £6/share.  If NII continues to expand from Q2 levels EPS could go much higher.  One peculiarity of UK banks is that they swap all of their assets to floating, so their NII reprices faster than most banks.  If reserves are strengthened £2.5 billion to year end 2020 levels, in the next 12 months, NatWest would earn something like £.17/share in that year, putting it at 15x the bear case EPS.

Seahorses.  Forever.

Catalyst

2022 earnings, NII expansion, capital return