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EMMA POWELL| TEMPUS

Rate NatWest higher at your peril

The Times

Rising interest rates have provided an easy tailwind for NatWest, the former Royal Bank of Scotland. Expectations that the tightening in monetary policy is nearing its peak and fresh turmoil in the banking sector have left immediate catalysts for the stock much less clear.

Might the best of the recovery in the shares since the pandemic be in the past? The London-based hedge fund Marshall Wace seems to think so, having built the biggest short-selling bet against NatWest recorded by the Financial Conduct Authority, at a 0.61 per cent net short position in the shares.

A target return on tangible equity of between 14 per cent and 16 per cent this year stands atop of rivals listed in London, building on an out-turn of 12.3 per cent over the course of last year. NatWest has a clear advantage over other mainstream lenders in capitalising on rising rates — a greater base of customer deposits, a cheaper source of funding than the wholesale market. Its loan-to-deposit ratio stood at 79 per cent last year, with customer deposits outnumbering wholesale lines six times over. Compare that with Lloyds, which has a loan-to-deposit ratio of 96 per cent and deposits outweighing wholesale funding by 4.7 times.

A lag in passing on the benefit of higher interest rates to depositors together with the boost from lending drove an increase in the net interest margin to 3.2 per cent by the fourth quarter of last year, from 2.3 per cent over the same period in 2021. That is expected to be the peak, with guidance for a 3.2 per cent margin over the entirety of this year, based upon the Bank of England’s base rate sitting at an average 4 per cent over the rest of this year, 25 basis points lower than at present.

Political pressure over the failure of banks to pass on enough of the boon of higher rates to savers might have pushed NatWest to be more conservative in its margin guidance, reckon analysts at RBC Capital, who have forecast a net interest margin of 3.3 per cent.

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As for NatWest falling prey to the same concerns over its financial strength that have caused other lenders to come unstuck in recent weeks, that should not be an issue. Its liquidity coverage ratio is a solid 145 per cent, above a regulatory minimum of 100 per cent. Such ratios are designed to ensure banks hold a sufficient reserve of high-quality liquid assets to survive a period of significant stress, namely customers pulling deposits lasting for 30 days. It also has a fat capital base. The bank’s common equity tier one ratio sits at 14.2 per cent, above target and a regulatory minimum of 9.5 per cent, even after the payment of last year’s 10p-a-share dividend and an £800 million share buyback.

State ownership is the big overhang to the shares. The deadline for the government offloading its stake of just over 41 per cent in the bank has been set for 2026. Last week it extended the trading plan to drip-feed out shares by another two years, to 2025, one of three methods of returning the bank to private ownership. That is hardly surprising given the market turbulence after the emergency rescue of Credit Suisse and the failure of a trio of US lenders last month. The other two options are share buybacks directed by the government and accelerated book-builds, larger sales of shares into the market. The latter seems far less likely in the present environment.

The higher cost of borrowing has weakened demand for mortgages and increased competition for new business for lenders. That is another headwind coming for big lenders. The gap between NatWest’s share price and its latest tangible net asset value is less than 10 per cent off the value forecast by analysts for the end of this year. Justifying anything approaching a premium is much harder.

ADVICE Hold
WHY The valuation is not appealing given the potential peak in interest rates

LXI Reit
Real estate investors face a crucial question: when will the fall in property valuations bottom out? The FTSE 250 group LXI Reit thinks that the trough was reached last month.

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If Simon Lee, who co-manages the real estate investment trust, is correct, then the heavy markdown in the company’s value looks more compelling. The shares languish at a 15 per cent discount to the net tangible asset value at the end of March and 24 per cent lower than the 134p-a-share forecast made by the brokerage Peel Hunt for the end of next March.

Some of the markdown has been justified. In the six months to the end of March alone, the net tangible asset value of the commercial landlord’s portfolio fell by 14 per cent, or 20p, to 120p a share. Warehouses and supermarkets suffered the worst declines — partly a function of some lofty starting values, but for the latter also a reflection of a diminished appetite from income Reits for deals.

LXI needs some valuation support. Its loan-to-value ratio is expected to sit at 38 per cent, above the medium-term target of 30 per cent. On the plus side, its refinancing of debt due over the next three years will mean that the trust has none falling due until 2026, and that will be at a fixed rate. Asset sales are planned, which together with an improvement in the commercial property market is expected to bring leverage back on target over the next one to two years.

Other help is also at hand. Over the next six months, almost half of the rent roll is up for review, which could provide a lift to values. About 80 per cent of rents are index-linked, even if there is a cap on the uplift of 4 per cent. If the rent reviews on the index-linked leases go through at that maximum level, around 5p a share would be added to the net tangible asset value, management reckons.

A beefy dividend of 6.3p a share was targeted for the financial year just gone, which, over the first six months at least, was fully covered by earnings. Given the progressive policy, analysts expect to increase the dividend to closer to 7p a share this year.

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ADVICE Buy
WHY Share discount could be appealing given the generous dividend on offer

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