NatWest

NatWest reported second-quarter operating profit of GBP 2.3 billion, up 12% sequentially on net interest income outpacing expenses.

Why it matters: Net interest income increased 3% from the first quarter, supported by a 2-basis-point net interest margin expansion and 1% average interest-earning assets growth. Similar to its UK peers, NatWest saw lending margin pressure, particularly in the mortgage market. Noninterest income increased 15%, albeit it is a smaller contributor to total income than net interest income. With the acquisition of Evelyn Partners, NatWest has more than doubled its assets under management and administration, beefing up its base from which it can generate fee income. Operating expense growth of 1.8% compared with income growth of 3.3% resulted in positive operating leverage effects. Lower impairments of 13 basis points versus 26 basis points in the first quarter also contributed to the good second-quarter results.

The bottom line: We raise our fair value estimate to GBX 750/$20.10 per share from GBX 710/$18.90 after lifting our net interest margin and capital distribution assumptions. Shares trade in 3-star territory. We maintain our Narrow Morningstar Economic Moat Rating. We believe that NatWest's access to low-cost and stable funding allows it to outearn its cost of equity comfortably in the midcycle. We model for a return on tangible equity of 18% versus a cost of equity of 9.9%. Given the current swap rate curve, we expect stronger benefits from the structural hedge, lifting our net interest margin assumption by 10 basis points. We also see greater capacity for capital distributions as a result of our increased margin assumptions.

BLANK PAGE

Our fair value estimate is $ 20.10 per share and corresponds to a multiple of 1.5 times 2026 estimated book value.

We assume bank net interest margins to peak at 270 basis points in 2028. We model for impairment losses of 25 basis points in 2026 growing to 35 basis points by 2028. Loan losses have been benign for an extended period now, supported by vast fiscal and monetary support. We are uncertain that the recent past is a good indicator of asset quality performance in the future. We model about 3% asset growth through our explicit forecast period. Our midcycle return on tangible equity is 18% versus a cost of equity assumption of 9.9%.

We assign NatWest a Narrow Morningstar Economic Moat Rating. We believe NatWest has a durable competitive advantage allowing the bank to consistently outearn its cost of equity. Through its retail franchise in the UK, NatWest has access to low-cost and stable funding, which we believe creates a cost advantage. Although barriers to entry in the UK banking market are relatively low, barriers to scale are high, protecting NatWest’s position as one of the largest UK-focused banks.

We believe that NatWest’s retail bank benefits from a deposit funding-based cost advantage. The four large banks, Barclays, Lloyds, NatWest, and HSBC, hold the majority of retail current account deposits (non-interest-bearing or low-interest-bearing accounts) in the UK. While household and corporate lending are competitive, the ability to earn a spread on the funding side sets these four banks apart.

Despite the launch of a customer current account switching service in 2013, the dominance of the large four UK banks controlling the majority of deposits has not changed materially. We believe that the large four banks in the UK benefit from scale and scope advantages that improve unit economics of owning and attracting deposits. Paired with low incentives to switch (that is, product homogeneity across the industry), we believe a large portion of the deposit funding controlled by the four large UK banks is sticky.

As of the first half of 2025, NatWest’s structural hedge includes GBP 172 billion of non-interest-bearing and low-interest-bearing deposits that display sticky and structurally stable characteristics. This covers about 33% of NatWest’s total funding requirement compared with 32% at Lloyds and 13% at Barclays.

The UK banking regulatory environment encourages new entries into the banking space, as is evidenced by the relatively high issuance of banking licenses in the UK. That said, growing a bank from a midtier to a large UK bank is difficult as capital and funding rules are tilted to the advantage of large-scale players. Banks with assets above GBP 40 billion are required to issue costly bail-in debt, which disproportionately disadvantages smaller challenger banks. Large UK banks also find it easier to spread the costs of operating internal risk-based models across their business compared with smaller banks. The advantage of running an internal risk-based model can be substantial, allowing a bank to apply lower risk weights to asset classes where standardized risk weights would have overcapitalized the bank through the last full credit cycle. Challenger banks often do not have a track record spanning a full credit cycle that could be used to build these advantaged risk models. Last, ring-fencing rules prevent large non-UK banks from quickly gaining scale within the UK. Any UK retail bank with assets above GBP 25 billion is required to be its own separate entity, with its own operations and infrastructure, and its own funding and capitalization.

Material value destruction is possible, but the potential impact is limited. NatWest takes on limited balance-sheet risk for modest capital markets, foreign exchange, and rates businesses, as well as lending to wholesale clients. That said, its balance sheet is primarily focused on mortgage lending (approximately 60%), exposing it to the UK economy and potential credit defaults of its borrowers. We view the likelihood of material value destruction as low and its impact as modest.

NatWest operates a strong retail and commercial banking franchise in the UK

NatWest has shown its ability to return capital to shareholders based on improved operating performance and a successful restructuring effort.

NatWest has a good capital position well above minimum requirements.

The mortgage market, a core segment for NatWest, remains competitive.

A recession in the UK could result in greater asset quality deterioration than anticipated.

Competition from challenger banks relying on different funding and business models could intensify again.