NatWest Group plc

Moat: 2/5

Understandability: 3/5

Balance Sheet Health: 4/5

NatWest Group plc is a major UK banking and financial services company, offering a wide range of services primarily to UK customers, with a growing international reach.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview

NatWest Group (NWG), formerly known as Royal Bank of Scotland Group, is a major UK-based banking and financial services institution. The company provides a range of services across retail, commercial, and investment banking. The key activities include:

  • Retail Banking: Offers current accounts, savings accounts, mortgages, and credit cards to individual customers across the UK and some international locations.
  • Commercial Banking: Provides lending, cash management, and international trade financing to UK businesses, from small enterprises to large corporations.
  • NatWest Markets: Their investment banking arm provides financing, risk management, and investment solutions to corporate, institutional and government clients.

Revenue Distribution

  • Interest Income: A significant portion of revenue comes from the difference between the interest rates it charges for loans and the rates it pays for deposits.
  • Fee and Commission Income: Fees from banking services, asset management, and transaction fees are also a substantial source of revenue.
  • Trading Income: Net trading income from financial instruments.
  • Other Income: Primarily consists of other nonbanking activities, such as insurance, and proceeds from asset sales.

Industry Trends:

  • The banking industry has been under intense regulatory and technological scrutiny which are driving up costs and creating some uncertainty for the company.
  • The UK’s economic condition has been very volatile and had very low growth over the past few years.
  • The high interest rates have allowed the company to make more money with its existing lending base.
  • Fintech competition is growing, putting pressure on traditional banking models.

Competitive Landscape

NWG competes in a highly regulated and competitive environment.

  • Major UK Banks: The company faces competition from major UK banks such as Barclays and Lloyds Banking Group, as well as global players like HSBC.
  • Digital Banks: The rise of digital-only banks like Monzo and Starling also pose a competitive threat by offering convenient and low-cost services.
  • Fintech Companies: Financial technology companies are introducing new and innovative products and disrupting some traditional banking functions, such as lending and payments.
  • Investment Banks: Their investment banking arm faces competition from a number of established bulge bracket companies like JP Morgan, Goldman Sachs, Morgan Stanley, etc.

Moat: 2 / 5

While NatWest possesses some elements of a moat, it falls into the narrow category and requires continuous monitoring to ensure value stability over time.

  • Switching Costs: For the retail banking segment, the company enjoys some benefit from the relative hassle of moving bank accounts, or even credit cards. Even though these are increasingly easy to swap, their long time relationship with their customers and difficulty in moving accounts can provide some retention.
  • Cost Advantages: Due to its huge size in the UK market, NatWest is able to leverage economies of scale to achieve relatively lower operating costs and obtain cheaper funding. The company also has a well-developed IT infrastructure that improves their back-office operations.
  • Intangible Assets: The Royal Bank of Scotland brand is relatively strong in the UK, but its name carries some negative connotation and can be difficult to replicate, but their are more prestigious brand names in the market. The company also benefits from several regulatory licenses and patents which are a minor source of advantage.
    • Weaknesses:
    • Switching costs are becoming increasingly weaker and companies can move a lot of their business online.
    • Cost advantage is easily replicable by other big banks due to the commoditized nature of financial products and the fact that its a well established business.
    • The company is very reliant on reputation and if the brand image decreases, that will severely affect its ability to maintain its large customer base.

Moat Risks and Business Resilience

  • Regulation: Changes in regulation are a major concern for all banks, and can significantly affect profitability. For example, the UK government can decide to make a lot of income that the banks generate illegal and put immense pressure on the company.
  • Technological Disruption: Rapid advancements in technology can alter how the banking industry functions, and thus undermine their business model. They must make significant capital outlays to keep up with the technology changes, potentially resulting in decreasing earnings.
  • Macroeconomic Volatility: Banks are highly sensitive to economic conditions, such as interest rates and economic cycles. A downturn in the economy can reduce demand for banking services and can increase the likelihood of loan defaults.
    • Business Resilience:
      • They have a large customer base that is widely distributed in the UK and several parts of the world, which diversifies their lending business.
      • They have been in business for over 300 years and have a proven and tested model of business operations.
      • They do have some regulatory advantages in place, and are also benefiting from strong relationships with customers.

Financials

NatWest’s financials reveal a large operation, but also note a volatile performance over the last few years:

  • Income Statement: The bank’s financials have had an unsteady trend due to the covid pandemic and the financial crisis which greatly affected its margins and revenues. Total revenue is around 13-14 billion GBP a year.
    • Net Interest Income: This revenue is volatile and directly connected to the Bank of England’s interest rate decisions.
    • Fees, Commissions, and Trading Income: The company has a very large trading operation and the revenue in this segment is extremely reliant on market sentiment.
    • Reported Earnings: Profits are highly reliant on the current economic environment, due to which the company has had difficulty in making a clear profit during the past few years. They also reported a large number of restructuring and non recurring expenses which have impacted their profitability. They also are constantly having impairments and write offs due to past wrongdoings.
    • Trend * The net income is expected to rise to around 5-7 billion GBP in the coming years and as a whole seems to be doing better now that the covid pandemic is waning away. * The major impact on revenue is that the bank is facing a lot of pressure from high interest rates, with higher deposit and debt rates eating away at their interest margins. * The company is expected to have more recurring charges related to their restructuring efforts and lawsuits.
  • Balance Sheet:
    • They have a large number of loans, which they have to ensure are profitable over the long term.
    • They have a large amount of assets, including mortgages, cash, and various other financial assets.
    • The bank is highly reliant on customer deposits for a large portion of its funds.
      • They are continuing with a process to reduce their operational liabilities
      • The debt/equity ratios appear relatively balanced which shows good stability.
  • Cash Flow: The company has been working on increasing its Free Cash Flow and are generating a very high amount of cash from operations, which ensures they are a well funded company.

Understandability: 3 / 5

While the core banking business model is not particularly hard to understand, the complexity comes from the global nature of the business and the sheer number of moving parts. Here are reasons why we have given it a 3 rating:

  1. Regulatory Complexity: The bank is operating in a highly regulated industry, and the influence of the different regulations of different countries make it very difficult to understand.
  2. Financial Instruments: The bank uses several complex financial instruments which are very hard for average investors to understand. The complex nature of the banks balance sheet and business operations, make it difficult for most investors to interpret.
  3. Numerous Moving Parts: The company operates in retail, commercial, and investment banking and their operations vary in complexity, making it difficult to analyze the company.
  4. Reliance on Macroeconomics: The company’s profits are tightly connected to the overall economic outlook, and thus you need to understand the impact macroeconomic factors might play on the company.
  5. Impact of Financial Regulations: Any new regulations imposed by the government can drastically change the risk profile and profitability of the company.

Balance Sheet Health: 4 / 5

NatWest possesses a healthy balance sheet, although there are a few red flags for a company in this sector:

  1. Stable Leverage: The Debt/Equity is under control and can easily meet its short-term and long term needs.
  2. Large Asset Base: The company has a large asset base and it has a diversified mix of assets.
  3. Dependence on Deposits: As a financial institution, it relies on customer deposits, which could potentially lead to a liquidity risk if there is an outflow of deposits, but this is offset by the large amount of cash the company maintains on its balance sheet.
  4. High Loan Portfolio: With a very large lending business there is a real concern that the current market conditions could affect loan defaults in the coming years.

Recent Controversies

NatWest Group has faced several challenges which have severely impacted its reputation. They were fined $337 million by US regulators after it plead guilty to a criminal charge concerning a bond-trading scheme and is still undergoing a lot of scrutiny and is subject to pending lawsuits. The fallout from the crisis in the UK banking market in recent years also affected it and there was a sharp drop in share price and a rise in funding costs. The bank is also facing pressure from shareholders to reduce the management’s compensation as they think it’s excessive. Management has stated its intent to continue to restructure and create long term sustainable value for its shareholders.