NatWest Group: Latest Irish Exit Clears The Path For Medium-Term Upside
Summary
- With the sale of its c. €7.6 billion Irish loan book, NatWest continues to make encouraging progress on its exit from Ireland.
- The bank stands to benefit from upcoming rate hikes and cost cuts, with the strong excess capital position also likely to drive an outsized capital return.
- With shares trading at an undemanding 0.7x P/TBV, NatWest offers investors compelling value.
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NatWest Group (NYSE:NWG), a leading UK financial services company, continues to make good progress on its phased withdrawal from Ireland, reaching a binding agreement with Permanent TSB Group ((OTCPK:ILPMF)) for the proposed disposal of its portfolio of branches, non-tracker mortgages, and performing micro-SME loans, as well as its Irish asset finance business. All in all, the deal comprises c. €7.6 billion of gross loans and 25 branches, with an expected close in FQ4 ‘22/FQ1 ‘23. Although the specific economic terms remain undisclosed, I view the transaction positively - exiting the unprofitable Irish operations should make the equity story simpler and more compelling going forward. With NatWest also set to be a key beneficiary of higher rates in the UK, the current 0.7x P/TBV valuation for 10% fiscal 2023 ROTE and a double-digit % total yield (buybacks and dividend) is compelling.
A Closer Look at the Announced Disposal of €7.6 Billion Loan Book to PTSB
NatWest has confirmed a binding agreement with PTSB for the sale of its c. €7.6 billion Irish loan book – this comprises c. €7 billion of performing non-tracker mortgages, c. €230 million of performing micro-SME loans, c. €400 million of Irish asset finance business, as well as 25 branches. In return, NatWest will receive 16.66% of PTSB's enlarged share capital in new shares and cash. At a combined c. 98% of par value, the sale entails a rough loss of c. €100 million for NatWest but releases net c. €300 million of balance sheet capacity. As things stand, the deal remains subject to competition, regulatory and PTSB's holding company shareholder approval. Assuming these hurdles are cleared, most of the loan book is set to transfer in FQ4 ’22, before the deal is projected for final completion between FQ4 ’22 and FQ1 ’23.
Notably, this deal comes right on the heels of NatWest’s agreement to sell €4.2 billion in commercial loans to AIB earlier in the year. Along with the PTSB deal, this implies binding agreements in place for a massive 58% of gross loans and 65% of credit risk RWAs, leaving €7-7.5bn of low yield, low credit risk tracker mortgages still to be run down. Assuming net CET1 accretion of c. 60bps from a reduction in RWAs (in-line with guidance), partly offset by a potential negative P&L impact, this would also imply €700+ million in capacity to absorb other exit costs and remain CET1 neutral. Looking ahead, I see further upside to current accretion estimates as well, considering AIB and PTSB have signaled plans to take on a significant portion of Ulster's annualized cost base.
Key Beneficiary of Upcoming Rate Hike and Cost Cutting Efforts
Heading into the upcoming year, NatWest appears well-positioned to benefit from higher rates in the UK. In particular, the large excess UK-based deposit base and the limited need to pass through higher rates on retail savings accounts mean its rate sensitivity is significantly higher than it used to be historically. Also worth noting is NatWest’s mainly managed rates corporate deposit base, which should allow the company plenty of room to extract managed margin improvement for the pending rate hikes. Complementing the rate hike tailwind is the implementation of its planned cost cuts, with the expense base guided to fall c. 4%/year (in line with current guidance). Assuming NatWest successfully navigates any wage inflation pressures in the UK and capitalizes on its structural hedges as well, I see a clear recovery path toward the medium-term income guidance of £0.8-1 billion.
Source: NatWest Investor Presentation Slides
Strong Funding Position Supports Capital Return Upside
Another key selling point is NatWest’s outsized scope for capital return (at least relative to the major European banks) – specifically, the bank has a massive 460bp spot excess capital position (equivalent to £7.3 billion as of its most recent quarter) and excess funding of £100 billion. And with NatWest signaling toward another £750 million buyback with the upcoming FQ4 ’21 results and a 7.2p/share final dividend, there is clear intent to boost the capital return. Combined, the directed and current general share repurchase would imply total shareholder return announced in fiscal 2021 in the double-digit % range (including dividend). Beyond this year, I continue to see scope for directed and general buybacks of c. 10%/year combined into fiscal 2023, as the company looks to reduces its excess capital position toward a CET1 ratio of 13-14%.
Source: NatWest Investor Presentation Slides
Final Take
On balance, NatWest’s recent agreement with PTSB for the sale of its performing non-tracker mortgages (c. €7 billion), performing micro-SME loans (c. €230 million), and Irish asset finance business (c. €400 million), as well as its 25 branch network, represents another positive step on the capital allocation front. Combined with the prior AIB transaction, the PTSB sale entails over €700 million in net capital freed to absorb restructuring and other exit costs, while also boosting NatWest's already-healthy balance sheet capacity. And while I acknowledge the ongoing restructuring efforts in the near term, the beneficial impact of higher UK rates in the upcoming year should far outweigh any transitory headwinds. As such, NatWest’s current valuation screens favorably, with its shares trading on a 0.7x TBV for a fiscal 2023 ROTE of 10.0% and a compelling double-digit % capital return.
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