FINANCIAL INSTITUTIONS

ISSUER COMMENT NatWest Group plc 30 October 2020 Q3 2020: Weak margins and one-off costs mitigated by lower loan impairment charges

All figures in this report relate to Q3 2020 and comparisons are made to Q3 2019, unless RATINGS otherwise indicated. NatWest Group plc BCA baa2 In Q3 2020, NatWest Group plc1 (NWG) reported a net attributable profit of £61 million, Senior unsecured Baa2 positive compared with a £315 million loss in Q3 2019. This profit was driven by lower provisions for expected credit losses (ECLs) of £254 million versus the prior quarter (Q2 2020: £2,056 National Westminster plc million; Q3 2019: £213 million); at the same time, NWG's net interest income fell largely BCA baa1 Long-term deposit A1 stable as a result of the lower base rate, and a recent liability management exercise (LME) led to Senior unsecured A2 positive high one-off costs of £324 million. The reported annualised return on tangible equity (RoTE) was 0.8%. We calculate an annualised attributable return on assets of 7 bps2 and a return on NatWest Markets plc risk-weighted assets (RWAs) of 34 bps3. NatWest Markets (NWM) operating performance BCA ba2 continues to be weak, as it reported an operating loss of £66 million. We view these results Long-term deposit Baa2 positive Senior unsecured Baa2 positive as credit neutral given the high levels of capital and liquidity mitigating the continuing pressures on net interest margin as well as ongoing restructuring costs from NWM.

The Royal Bank of International ECL provisions fell to pre-coronavirus levels. NWG booked £254 million provisions for BCA baa1 ECLs (28 of loans) in Q3, which follow £2.9 billion taken in H1 2020. NWG’s multiple Long-term deposit Baa1 positive Issuer rating Baa1 positive economic scenario remained broadly unchanged from June. As the macroeconomic scenarios didn't materially change, government measures and bank forbearance limited defaults, and Source: Moody's Investors Service considering the large provisions in H1 2020, total ECL reserves were mostly unchanged compared with Q2 2020 at £6.4 billion; however, given the large ECL provisions in 2020, ECL reserves are materially higher than the £3.8 billion at year-end 2019. The majority of the Contacts ECL reserves pertain to Stage 2 loans (48% of total ECL reserves), which have been 26% of Edoardo Calandro +44.20.7772.1097 NWG's gross loans since Q2 2020. In line with peers, NWG estimates full year impairment VP-Senior Analyst charges to be at the lower end of the guidance range of £3.5-4.5 billion that they provided in [email protected] Q2 2020; the range equals to c.1% to c.1.2% of NWG's loans and advances. We continue to Maxwell Price +44.20.7772.1778 expect ECLs to be high in the coming quarters, albeit still lower than the peak in Q1 and Q2 Associate Analyst 2020. At the same time, downside risks remain material as coronavirus cases continue to rise [email protected] and as further restrictive measures are imposed, potentially leading to higher-than-expected Laurie Mayers +44.20.7772.5582 credit losses. Associate Managing Director [email protected] Revenue (indicated by NWG as 'total income') decreased 17%, driven by lower Nick Hill +33.1.5330.1029 demand for credit and one-off LME charges. Net interest income declined 4% against Q3 MD-Banking 2019, largely reflecting the lower base rate. The net interest margin (NIM, excluding NWM) [email protected] declined to 165 bps from 167 bps the prior quarter and 197 bps in Q3 2019, reflecting the continued pressure in the mortgage market and NWG's decision to temporarily halt the offer of high loan-to-value mortgages in Q3 2020, and downward movement of the yield MOODY'S INVESTORS SERVICE FINANCIAL INSTITUTIONS

curve. Non-interest income decreased 45%, driven by one-off losses deriving from a recent LME, lower fee income on retail and commercial products due to lower customer activity, as well as asset disposals and negative own credit adjustments at NWM. We anticipate group's revenues will continue to come under pressure in the coming quarters due to lower customer activity and a prolonged period of low interest rates in the UK.

Adjusted operating costs excluding conduct charges decreased 7%, due to lower staff costs and administrative expenses. Staff costs declined 7% due to reduced headcount. Strategic costs remained elevated, but in line with the group's guidance, at £223 million (Q319: £215 million), which included a £90 million charge for one-off staff costs, as well as an £67 million charge for restructuring at NWM. Litigation and conduct costs of £8 million were substantially lower than prior year, which included a £900 million charge for Payment Protection Insurance (PPI). We believe costs will normalise over the coming year, as strategic charges and litigation and conduct costs decline.

Capitalisation remains strong and well-above peers. NWG reported a Common Equity Tier 1 (CET1) ratio of 18.2%, an increase of 100 bps against Q2 2020. This is materially above the medium-term target of c.13-14% reaffirmed by NWG's management, and above the regulatory maximum distributable amount (MDA) requirement of 8.9%. The increase in the CET1 ratio was driven by a decline in risk-weighted assets (RWAs; +58 bps), profits excluding LME (+18 bps) other movements (+18 bps) and infrastructure and SME factors (+17 bps), partially offset by LME (-15 bps). Total RWAs decreased £7.6 billion to £173.9 billion, driven by reduced risk components: credit risk, £3.3 billion; counterparty credit risk, £2.2 billion and market risk, £2.1 billion. Management updated their previous estimate for total RWAs at year end, with their expectation total RWAs will be below the previously guided range of c.£185 - £195 billion, due to lower procyclical inflation and a quicker than forecast run-down of RWAs at NWM. RWAs at NWM decreased £5.1 billion in the quarter to £30 billion, with management targeting year-end RWA’s to remain stable and reaffirming the £20 billion target in the medium-term. NWG indicated that they want to reach most of the RWA reduction for NWM in 2021.

Exhibit 1 Capitalisation is strong and remains above UK peers Common Equity Tier 1 (CET1) ratio and Tier 1 UK Leverage Ratios, end-September 2020

CET1 Ratio Tier 1 (UK) Leverage ratio Median UK peers CET1 ratio (15.2%) Median UK peers leverage ratio (5.6%) 20.0% 18.2% 18.0% 15.6% 15.2% 16.0% 14.6% 14.4% 14.0%

12.0%

10.0%

8.0% 6.2% 6.1% 5.6% 6.0% 5.2% 4.9%

4.0%

2.0%

0.0% NatWest Group HSBC Holdings plc plc Santander UK Source: Company data, Moody's Investors Service

Funding and liquidity remain strong. NWG reported a Basel III Net Stable Funding Ratio (NSFR) of 147% (Q2 2020: 138%) and a strong Liquidity Coverage Ratio (LCR) at 157%. Liquid resources at end Q3 were £243 billion, representing a surplus above regulatory requirement of £88 billion. Liquid resources were more than three times NWG's £75 billion of total wholesale funding, and substantially higher than the group's £25 billion short-term wholesale funding.

This publication does not announce a credit rating action. For any credit ratings referenced in this publication, please see the ratings tab on the issuer/entity page on www.moodys.com for the most updated credit rating action information and rating history.

2 30 October 2020 NatWest Group plc: Q3 2020: Weak margins and one-off costs mitigated by lower loan impairment charges MOODY'S INVESTORS SERVICE FINANCIAL INSTITUTIONS

Results by division

Exhibit 2 Most business lines returned to profit in Q3, NatWest Markets booked a loss Reported quarterly pre-tax profits by business line

UK PB Commercial Banking Natwest Markets Other 2,000

1,500

1,000

500

- £ million £ (500)

(1,000)

(1,500)

(2,000) Q3 2019 Q4 2019 Q1 2020 Q2 2020 Q3 2020 Note: Business Banking was reclassified under Commercial Banking from UK Personal & Business Banking “UK PBB” as at the start of 2019, prior period comparatives reflect this change. “UK PB” denotes UK Personal Banking. “Other” includes results for , RBS International and Central items & other. Source: Company data

Noteworthy credit trends within individual business lines in Q3 2020 (% rounded) compared with Q3 2019 include the following:

Retail Banking reported an operating profit of £305 million4 (£508 million loss in Q3 2019). Revenue declined 17%, driven by lower fees, mortgage market competition and lower fees related to international spend. The NIM fell 13 bps against the prior quarter to 2.05% and decreased 39 bps compared with Q3 2019. Adjusted operating costs decreased 8% to £640 million5. Impairment charges fell to £70 million from £360 million in Q2 2020 and £131 million Q3 2019, given charges already taken in the first half of 2020. Mortgage repayment holidays have declined to £6.2 billion (c.4% of the lending book) from the peak of £33.6 billion (c.22% of the lending book).

The Commercial Banking (CB) division's operating profit was £324 million, a small decline from the £331 million in Q3 2019. The profit was driven by a normalised impairment charge of £127 million, due to NWG’s unchanged economic scenarios and the charges already taken in the first half of 2020. Revenue decreased 7% due to yield curve contraction and lower customer activity. The net interest margin decreased 2 bps to 1.67% from the prior quarter and 1.90% in the prior year quarter. Adjusted operating costs (excluding legacy) decreased by 7%, driven by lower headcount and back office resources. Active payment holidays represented c.8% of the lending book.

Ulster Bank Republic of Ireland (UBI) reported an operating profit of €1 million, compared with a €34 million profit in Q3 2019. Revenues fell 10% to €145 million reflecting lower client activity due to coronavirus. Credit impairment charges decreased to €6 million, with payment breaks mitigating the full impact of credit impairments. This compares with a €19 million total impairment release in Q3 2019. For customers who opted for a payment break in March, 46% have opted to take a second payment break, representing 8% of the total lending book. Operating costs were marginally lower at £138 million.

NatWest Markets' (NWM)division recorded an operating loss of £66 million compared with an operating loss of £193 million in Q3 2019. Adjusted revenue increased 74% to £280 million, driven by higher client activity, although this has moderated compared with the first half 2020. Revenue from Fixed Income increased to £125 million from £17 million in Q3 2019 due to higher client activity in Q3 2020 and elevated hedging costs in Q3 2019; Currencies revenue increased 6% to £126 million from Q3 2019. Total operating costs (including strategic and litigation costs) decreased 13%. Total impairment releases were £2 million in Q3 2020, against a £45 million charge in Q2 2020 and a £5 million release in Q3 2019. RWAs declined £5.1 billion in the quarter to £30 billion, with management expecting year-end RWAs to remain unchanged. Management also reaffirmed its medium-term RWA target of c.£20 billion, but they indicated that they are targeting to complete most of the reduction in 2021.

3 30 October 2020 NatWest Group plc: Q3 2020: Weak margins and one-off costs mitigated by lower loan impairment charges MOODY'S INVESTORS SERVICE FINANCIAL INSTITUTIONS

Ratings Considerations NWG's senior unsecured long-term debt is Baa2, and the group' notional baseline credit assessment is baa2. The outlook on NWG's senior holding rating is positive, reflecting our view that the group will largely complete its complex multi-year restructuring exercise and will generate more stable and sustainable earnings post coronavirus. Moody’s related publications Credit Opinion

» NatWest Group plc, 2 October 2020

» National plc, 21 October 2020

» NatWest Markets plc, 2 October 2020

» The Royal International Ltd, 2 October 2020

Banking System Outlook

» : Coronavirus, weaker operating environmentand margins drive negative outlook, 26 March 2020

To any of these reports, click on the entry above. Note that these references are current as of the date of publication of this report and that more recent reports may be available. All research may not be available to all clients. Endnotes 1 NWG, LT senior unsecured Baa2 positive, baseline credit assessment baa2. 2 We calculate the annualised return on assets using the reported annualised (4x) after-tax profits for the quarter, divided by total assets end-Q3 2020, 3 We calculate the annualised return on risk-weighted assets using the reported annualised (4x) after-tax profits for the quarter, divided by total risk- weighted assets end-Q3 2020 4 The reported operating profit at the UK Personal Banking division has been adjusted for the transfer of the Business banking unit to Commercial banking. 5 Comparisons with prior periods are impacted by the transfer of the Private Client Advice business to Private Banking from 1 January 2020. The net impact on Q2 2019 operating profit would have been to decrease total income by £11 million and operating expenses by £2 million.

4 30 October 2020 NatWest Group plc: Q3 2020: Weak margins and one-off costs mitigated by lower loan impairment charges MOODY'S INVESTORS SERVICE FINANCIAL INSTITUTIONS

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6 30 October 2020 NatWest Group plc: Q3 2020: Weak margins and one-off costs mitigated by lower loan impairment charges