Analysts are buzzing about NatWest Group's Q1 2024 earnings call, dissecting the stabilizing NIM, the cautiously optimistic lending outlook, and the continued government share reduction. But hidden beneath these headline-grabbing details lies a far more intriguing story – one that seems to have slipped past the radar of even the most seasoned financial experts.

The key lies in the subtle shift in NatWest's messaging around its structural hedge. Previously viewed as a stabilizing force, a bulwark against the volatility of a declining interest rate environment, it's now being presented as something much more potent: a catalyst for future income growth.

This shift is not merely rhetorical. Digging deeper into the transcript reveals intriguing clues that point towards the hedge evolving into a revenue powerhouse. Firstly, consider the reinvestment yield. While the notional value of the hedge is expected to shrink to around £170 billion by the end of 2024, NatWest anticipates reinvesting maturing portions at an average yield of 310 basis points. This is significantly higher than the roll-off yield, estimated to be around 80 basis points for 2024 and 50 basis points for 2025.

The math here is compelling. If we assume a conservative estimate of £35 billion maturing each year (based on a 2.5-year average life and £170 billion notional), the reinvestment alone generates a yearly uplift of approximately £807.5 million.

But the real story unfolds as we look further ahead. Katie Murray, NatWest's CFO, hinted that deposit stabilization is expected by mid-2024. This implies that from H2 2024 onwards, the reinvestment dynamic kicks into overdrive, with the full £35 billion (or potentially even more) being reinvested at those attractive yields.

This potential for explosive hedge-driven income growth is further bolstered by Murray's comments about the reinvestment yield in 2025 and 2026. While she anticipates a slight decline from the 310 basis point figure, she emphasizes that it will not be "meaningfully" lower. This implies that the hedge will continue to generate significant income uplift for the foreseeable future.

Consider this against the backdrop of NatWest's ambitious RoTE target of greater than 13% by 2026. Analysts, fixated on the impact of potential rate cuts, seem to have underestimated the potential of the structural hedge to propel income growth, even in a declining rate environment. Consensus forecasts for NII growth in 2025 and 2026 hover around a paltry £400 million to £500 million. However, factoring in the potential hedge tailwind, it's not unreasonable to hypothesize that NII growth could be double or even triple that figure.

This potential for outsized NII growth, coupled with the expected stabilization of mortgage margins and a continued focus on disciplined cost control, paints a far more optimistic picture than what consensus currently reflects.

This is not to say that NatWest's path is without challenges. The bank still faces headwinds from potential rate cuts, competitive pressures in the mortgage and deposit markets, and the ongoing unwinding of its cash flow hedge reserve.

However, the strategic repositioning of the structural hedge from a stabilizing force to a growth engine suggests a bold new chapter in NatWest's story. The bank, once burdened by its legacy and government ownership, is leveraging its unique balance sheet structure and disciplined approach to not only weather the current economic storm but to emerge as a formidable player in the years to come.

Net Interest Margin (NIM) Analysis

The following table breaks down NatWest's Net Interest Margin (NIM) for Q4 2023 and Q1 2024, showing the impact of various factors. Data sourced from the respective earnings call transcripts.

Projected Structural Hedge Income Growth

The following chart illustrates the potential for NatWest's structural hedge to generate significant income growth in the coming years. Based on data from Q1 2024 earnings call and analyst estimates.

"Fun Fact: NatWest Group is the largest corporate and institutional bank in Scotland, providing banking services to over 80% of Scottish businesses."