credit challenges natwest markets plc/media/files/r/rbs... · 1/22/2019 · for any credit ratings...

FINANCIAL INSTITUTIONS

CREDIT OPINION22 January 2019

Update

RATINGS

NatWest Markets PlcDomicile United Kingdom

Long Term CRR A3

Type LT Counterparty RiskRating - Fgn Curr

Outlook Not Assigned

Long Term Debt Baa2

Type Senior Unsecured - FgnCurr

Outlook Positive

Long Term Deposit Baa2

Type LT Bank Deposits - FgnCurr

Outlook Positive

Please see the ratings section at the end of this reportfor more information. The ratings and outlook shownreflect information as of the publication date.

Contacts

Alessandro Roccati +44.20.7772.1603Senior Vice [email protected]

Laurie Mayers +44.20.7772.5582Associate Managing [email protected]

Nick Hill [email protected]

CLIENT SERVICES

Americas 1-212-553-1653

Asia Pacific 852-3551-3077

Japan 81-3-5408-4100

EMEA 44-20-7772-5454

NatWest Markets PlcSemi-annual update 2019

Summary rating rationaleWe rate NatWest Markets Plc's (NWM; previously the Royal Bank of Scotland plc) seniorunsecured debt and deposits at Baa2 (long-term) and Prime-2 (short-term) and itscounterparty risk rating (CRRs) at A3(cr) long-term) and P-2(cr) (short-term).

We align the ratings of the Dutch entity NatWest Markets N.V. (NWM NV; previously RoyalBank of Scotland N.V.) to those of NWM, based upon our expectation that NWM NV willbecome the main entity for the group’s wholesale activities in the European Union (EU) oncethe United Kingdom (Aa2 stable) leaves the EU and that it will remain highly integrated withNWM.

NWM is the group’s non-ring fenced bank. Its ba2 BCA reflects: (1) inherently less diversifiedand less stable earnings, which are exposed to volatility and tail risk from the large capitalmarkets activities; (2) weak profitability due to continued high restructuring costs and losseson legacy assets; and (3) high use of wholesale funding, albeit mitigated by sound liquidity.

Credit strengths

» High liquidity mitigates reliance on confidence-sensitive wholesale funding

» High volume of senior unsecured debt results in two notches of loss-given failure uplift

» Moderate probability of government support results in one notch uplift incorporated in itsCounterparty Risk Rating

Credit challenges

» High capital markets activities exposes the bank to tail-risk and earnings volatility

» Weak profitability due to ongoing restructuring costs and losses on legacy assets

http://www.surveygizmo.com/s3/1133212/Rate-this-research?pubid=PBM_1157092

https://www.moodys.com/credit-ratings/NatWest-Markets-Plc-credit-rating-651920

https://www.moodys.com/credit-ratings/NatWest-Markets-NV-credit-rating-24340

MOODY'S INVESTORS SERVICE FINANCIAL INSTITUTIONS

Rating outlookNWM’s and NWM NV’s ratings outlook is positive, reflecting our expectation that fundamentals will improve over the next eighteenmonths as the non-core unit will wind-down further, tail risk from legacy litigations recedes and the bank substantially completes itsrestructuring enabling it to generate more stable and sustainable earnings.

Factors that could lead to an upgrade

» NWM’s and NWM NV’s ba2 BCA could be upgraded if NWM were to substantially complete its restructuring, its asset risk profilewere to improve due to run-off or disposal of its legacy assets, its profitability and efficiency improved on a sustainable basis, and/orits capitalisation were to increase significantly.

» An upgrade of the BCA would likely lead to an upgrade of all ratings. An upgrade could also result from an upgrade of the notionalBCA of RBSG, which would likely provide support to these entities in case of need. An upgrade of NWM's and NWM NV's long-termsenior unsecured debt and deposit rating could also result from a higher-than-expected stock of more junior bail-in-able liabilitiesthat would provide greater protection for senior liabilities.

Factors that could lead to a downgrade

» NWM’s and NWM NV’s BCAs of ba2 could be downgraded in the event of: (1) a substantial increase in riskier trading activities;(2) a decline in capitalisation; (3) large losses from its book of legacy assets; (4) a material weakening of the liquidity profile; or(5) large unexpected additional restructuring costs. A downgrade of the BCA would likely lead to a downgrade of all ratings. Adowngrade could also result from a downgrade of the BCA of RBSG, indicating lower likelihood of support. The ratings could also bedowngraded due to a reduction in the stock of bail-in-able liabilities that would reduce the degree of protection for senior ratings.

Key indicators

Exhibit 1

NatWest Markets Plc (Consolidated Financials) [1]6-182 12-172 12-162 12-152 12-142 CAGR/Avg.3

Total Assets (GBP billion) 576 550 531 544 687 -4.94

Total Assets (EUR billion) 651 620 623 738 885 -8.44

Total Assets (USD billion) 760 744 657 801 1,071 -9.34

Tangible Common Equity (GBP billion) 11 35 29 35 35 -28.44

Tangible Common Equity (EUR billion) 12 39 34 48 46 -31.04

Tangible Common Equity (USD billion) 15 47 36 52 55 -31.74

Problem Loans / Gross Loans (%) - - 2.9 3.6 7.6 4.75

Tangible Common Equity / Risk Weighted Assets (%) 24.3 25.4 16.3 17.3 13.4 19.46

Problem Loans / (Tangible Common Equity + Loan Loss Reserve) (%) - - 26.2 25.4 47.5 33.05

Net Interest Margin (%) -0.1 0.0 0.0 1.4 1.3 0.55

PPI / Average RWA (%) -1.8 -1.5 -2.9 -1.1 0.5 -1.46

Net Income / Tangible Assets (%) 0.3 0.3 0.5 -0.3 0.2 0.25

Cost / Income Ratio (%) 248.6 378.5 589.8 121.3 88.2 285.35

Market Funds / Tangible Banking Assets (%) 17.5 13.7 16.4 21.4 25.5 18.95

Liquid Banking Assets / Tangible Banking Assets (%) 7.4 12.2 35.2 38.4 35.2 25.75

Gross Loans / Due to Customers (%) 172.8 460.6 88.0 88.1 95.3 181.05

[1] All figures and ratios are adjusted using Moody's standard adjustments. [2] Basel III - fully-loaded or transitional phase-in; IFRS. [3] May include rounding differences due to scaleof reported amounts. [4] Compound Annual Growth Rate (%) based on time period presented for the latest accounting regime. [5] Simple average of periods presented for the latestaccounting regime. [6] Simple average of Basel III periods presented.Source: Moody's Financial Metrics

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 onwww.moodys.com for the most updated credit rating action information and rating history.

2 22 January 2019 NatWest Markets Plc: Semi-annual update 2019


ProfileNWM conducts mostly capital markets activities on behalf of the group. NWM has a weak credit profile as it is largely market funded,has a sizeable trading and repo book, and provides broker-dealer capabilities. We reflect the complexity of the bank's multi-yearrestructuring program, the high level of operational risk associated with the execution of its restructuring, including structural reform, ina one-notch negative adjustment for Corporate Behaviour, in the qualitative section of our BCA scorecard.

NWM NV will likely become the entity conducting wholesale activities in the European Union outside the UK. Together, the twoentities will account for around 15% of group risk-weighted assets (RWAs).

Other group entities

The ring-fenced bank subgroup (under an intermediate holding company, NatWest Holdings Ltd) retains retail & commercial bankingactivities and accounts for around 80% of group RWAs. The ring-fenced bank sub-group includes National Westminster Bank Plc(NWB; long-term issuer rating A2 positive), Ulster Bank Ireland DAC (long-term deposits Baa1 positive), Ulster Bank Limited (UBL, long-term issuer rating A2 positive) The Royal Bank of Scotland plc (RBS plc, previously: Adam and Company PLC; long-term deposit ratingA1 positive), and Coutts & Company (unrated).

Exhibit 2

Previous and proposed simplified legal entities group structure

Source: Moody’s Investors Service on Company data

Detailed credit considerationsHigh capital markets activities exposes the bank to tail-risk and earnings volatilityAs a result of the implementation of ring-fencing, NWM has a weak credit profile, as it is the group’s principal entity for conductingcapital markets and some other wholesale activities, has a sizeable derivatives and repo book, and provides broker-dealer capabilities.We consider these activities to be typically more confidence sensitive, opaque and complex and subject to greater earnings volatilitythan retail and commercial banking.

Despite the ongoing reduction of the bank's capital markets operations, NWM retains a decreased but still large presence in globalcapital markets reflecting the group’s objective to support its corporate and financial institution clients, as well as the marketsrequirements of its ring fenced affiliates.

Capital markets revenues are inherently volatile, as they largely depend on market conditions, and are more confidence sensitive.These risks are reflected in our asset risk score of ba1. The high degree of volatility of capital markets revenues and inherent althoughdecreasing risks carried by this type of activity for the group are reflected in a one-notch negative adjustment for opacity and



complexity, in the qualitative section of our BCA scorecard, in line with the treatment for other banks with material capital marketsactivities.

NWM had total RWAs of £45.2 billion at end-June 2018, of which £16.1 billion related to market risk. This was significantly lower thanthe £136.8 billion RWAs reported at year-end 2017, due to the transfer of assets to the ring-fenced entities.

Weak profitability due to ongoing restructuring costs and losses on legacy assetsThe potential earnings volatility stemming from the bank's capital markets activities, is further exacerbated by ongoing restructuringcosts, and potential litigation settlements. In 1H 2018, NWM reported an operating loss of £0.8 billion (a decrease versus a 1H 2017operating loss of £0.4 billion) driven by costs relating to residential mortgage backed securities and litigation. We expect NWM tocontinue to report net losses over the outlook period, due to high restructuring costs and losses on legacy assets.

The assigned profitability score of b1 reflects the ongoing profitability challenges at the bank. In order for the bank to achieve asustainable level of profitability, the efficiency of the core capital markets activities will need to improve.

High liquidity mitigates reliance on confidence-sensitive wholesale fundingIn line with other capital market participants, NWM has large wholesale (secured and unsecured) short-term funding requirements,which increase the institution's sensitivity to market confidence.

Positively, its liquidity position benefits from a large amount of liquid assets, held as a result of its mostly plain vanilla capital marketsbusiness and as investments of the down-streamed MREL debt.

Our assigned funding and liquid resources scores are b3 and aa3 respectively, resulting in a combined liquidity score of ba1.

Notching ConsiderationsAffiliate supportWe incorporate a “High” level of support from the holding company The Royal Bank of Scotland group , resulting in one notch ofaffiliate support, and leading to an adjusted BCA of ba1 (from a BCA of ba2).

Loss Given FailureHigh volume of senior unsecured debt resulting in two notches of loss-given failure uplift from the BCA.

We apply our advanced Loss Given Failure (LGF) analysis to NWM as it is domiciled in the UK, which we consider as an operationalresolution regime, following the implementation of the EU Bank Resolution and Recovery Directive (BRRD). We include NWM NV inthe same at failure waterfall as NWM, due to the ongoing transfer of assets to the UK entity. We assume: (1) residual tangible commonequity at failure of 3% of tangible banking assets, (2) losses post-failure of 13% of tangible banking assets, (3) junior wholesale depositsaccounting for 100% of the bank's total deposit book, (4) a 25% run-off in junior wholesale deposits, and (5) a 25% probability ofdeposits being preferred to senior unsecured debt. For the at failure balance sheet, we consider NWM’s stand alone perimeter, as wedeem this to be the resolution perimeter adopted by the regulator.

Under Moody's advanced LGF analysis, the long-term senior unsecured debt and deposit ratings of NWM and NWM NV incorporatetwo notches of uplift, and the Counterparty Risk Assessment incorporates three notches of uplift, reflecting very low losses in the eventof the bank’s failure.

Government SupportGiven the low level of systemic importance of these non ring-fenced entities, we expect a low probability of government supportfor NWM’s and NWM NV’s deposits, senior unsecured debt and other junior securities, resulting in no uplift. The CRR incorporatesa one-notch uplift for government support, given our view that there is a moderate probability of support for the bank's holders ofoperational liabilities from the UK government, due to the interconnectedness of the bank’s capital markets activities with other partsof the global financial system.

Counterparty Risk Ratings (CRR)Moody’s Counterparty Risk Ratings (CRRs) are opinions on the ability of entities to honour the uncollateralised portion of non-debtcounterparty financial liabilities (CRR liabilities) and also reflect the expected financial losses in the event that such liabilities are not



honoured. CRR liabilities typically relate to transactions with unrelated parties. Examples of CRR liabilities include the uncollateralisedportion of payables arising from derivative transactions and the uncollateralised portion of liabilities under sale and repurchaseagreements. CRRs are not applicable to funding commitments or other obligations associated with covered bonds, letters of credit,guarantees, servicer and trustee obligations, and other similar obligations that arise from a bank performing its essential operatingfunctions.

NWM's CRR is positioned at A3/P-2. The CRR is three notches above the bank's standalone BCA of ba1. The uplift derives from thebuffer against default provided to the operating obligations by substantial bail-in-able debt and deposits. Although NWM's is likelyto have more than a nominal volume of CRR liabilities at failure, this has no impact on the CRRs because the significant level ofsubordination below the CRR liabilities at the bank already provides the maximum amount of uplift under our rating methodology.

The CRR also benefits from one notch of government support, in line with our assumption for CR Assessment.



Ratings

Exhibit 3Category Moody's RatingNATWEST MARKETS PLC

Outlook PositiveCounterparty Risk Rating A3/P-2Bank Deposits Baa2/P-2Baseline Credit Assessment ba2Adjusted Baseline Credit Assessment ba1Counterparty Risk Assessment A3(cr)/P-2(cr)Senior Unsecured Baa2Subordinate Ba3Jr Subordinate -Dom Curr Ba3 (hyb)Commercial Paper P-2Other Short Term (P)P-2

PARENT: THE ROYAL BANK OF SCOTLAND GROUPPLC

Outlook PositiveBaseline Credit Assessment baa2Adjusted Baseline Credit Assessment baa2Senior Unsecured Baa2Subordinate Baa3Jr Subordinate Ba1 (hyb)Pref. Stock Non-cumulative Ba2 (hyb)Pref. Shelf Non-cumulative (P)Ba2Commercial Paper P-2Other Short Term (P)P-2

Source: Moody's Investors Service



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Contacts

Nick Hill [email protected]

Laurie Mayers +44.20.7772.5582Associate [email protected]

Alessandro Roccati +44.20.7772.1603Senior Vice [email protected]

CLIENT SERVICES

Americas 1-212-553-1653

Asia Pacific 852-3551-3077

Japan 81-3-5408-4100

EMEA 44-20-7772-5454


credit challenges natwest markets plc/media/files/r/rbs... · 1/22/2019 · for any credit ratings...

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