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What first attracted me to the 9%-yielding Natwest preference shares

Natwest preference shares

Important: What follows is not a recommendation to buy or sell any shares. I’m just a private investor, storing and sharing notes. Read my disclaimer.

I bought some Natwest preference shares using the cash I raised at the end of March. I admit it!

Okay, so I meant to take risk off the table when I sold about 15% of my share portfolio – as well as doing a bit of capital gains tax management.

But have you seen the returns on cash? 1.5% after tax? I just couldn’t do it. You’re only young-ish once!

Besides, I’d say I’ve still achieved some diversification by buying these Natwest preference shares.

(The rest of my free cash? Some went back into shares made cheaper by the Euro wobbles. I also plan to invest some in index-linked National Savings certificates. The rest will stay in cash).

Diversification, but not as we know it

I admit investing in still-shunned bank securities might not be the sort of diversification you’d take home to meet your mother:

  • I’ve swapped FTSE 100 market risk for banking meltdown risk.
  • I’ve specifically banked on Natwest not going bust.
  • I’ve replaced wholly unknown ordinary share returns for a fixed income payment, plus potential capital gains.

But for someone who has no fixed interest exposure, it’s a baby step forward.

Would I rather hold UK government bonds at a 5% yield to this Natwest security yielding 9%? You bet! But 10-year gilts are only yielding 3.75%, while even undated gilts are offering less than 5%.

Beggars can’t be choosers.

Natwest Preference Shares: The details

Many bank preference shares plunged in value in 2008 and early 2009, and have not yet fully recovered.

After I brushed up on the asset class, I decided to play it safe with these Natwest preference shares.

In my opinion (and that’s all it is!) they look the least risky of those still offering unusually high yields. That limits their upside too, of course.

Natwest 9% Preference Shares

Ticker: NWBD
To buy: 101.5p
Coupon: 9%
Running yield: 8.9%
Payments: Twice yearly
NWBD summary on Digital Look

Particular features of the NWBD shares

  • Perpetual: With luck, these will payout that 9% coupon forever!
  • Non-cumulative: If the cash dividend is skipped, you’re paid it in more shares at a rate of 4/3 in kind.
  • Mandatory: These Natwest preference shares have escaped the EU barring of payments due to state aid concerns, unlike ‘discretionary’ issues such as Lloyds’.

Note that preference shares are quoted ‘dirty’. This means the price is not adjusted to take into account that an element of the next dividend payment has already accrued.

The last dividend payment made was in April, so buying now, a month into the next six-month period, means the shares are effectively yielding a tad over 9%.

The risks

My Natwest preference shares are yielding roughly 9%, whereas undated gilts are yielding around 4.8%. Clearly the market is not convinced they’re out of the woods yet – even if the days of 20% yields are long gone.

I think the risks are acceptable:

  • Natwest is owned by RBS, which has already been semi-nationalised and raked over by Her Majesty’s Government.
  • Stephen Hestor, the CEO, seems extremely capable.
  • If the bank was going to go bust or be nationalised, I think it would have been.
  • Natwest bank itself is a separate legal entity to parent RBS.
  • It’s enjoying less competition (due to the demise of Northern Rock and so on) and cheap money from the Bank of England.
  • Natwest bank has billions in assets; the dodgy assets are mostly in RBS.

The big unquantifiable danger is a banking crisis that wipes out pretty much all the banks – even boring ones like Natwest.

Such an eventuality was very possible in 2009 when the banks were in turmoil. I don’t think it’s likely now.

A lesser risk is that we see a huge UK housing crash sufficient to bring down lenders like Natwest. I think house prices will be choppy, but I don’t see much evidence that they’re going to fall by 40 to 50%.

What about George Osborne and Vince Cable’s mooted moves on the banking system? Well, I’m pretty relaxed about that.

Natwest is a boring retail bank of the kind politicians say they want more of. This Natwest preference share issue is just £180 million or so in size, which isn’t going to require ‘casino banking’ returns to maintain. (There’s also a second issue of Natwest preference shares of a similar negligible size).

The final risk is inflation and long-term interest rates. If conditions ever return to normal, then these changes will be what drives the Natwest preference shares’ price – just as it should be.

What about the rewards?

It’s hard to imagine my Natwest preference shares will trade near their 2006 high of 160p anytime soon, even if interest rates and inflation stay low for the next few years.

I could though imagine the spread over undated gilts narrowing in a sustained recovery. Say from the current 4.2% over gilts to around 2% to 2.5%.

That would equate to a yield on the prefs of around 6.5% to 7% at today’s rates. In turn would mean a price for the shares of around 130p to 140p.

Let’s call it 130p by 2015, just as a finger in the air estimate.

To see reach that price, the shares would need to increase by a compound annual rate of 5.5%. Add the 9% running yield on my purchase price, and I’m looking for a total return of almost 15% a year.

That looks attractive compared to average UK nominal equity returns of around 8% a year. But as I say, it’s only an estimate.

I’m not banking on it

I’ve only put a couple of percent or so of my total net worth into these Natwest securities. Perhaps I’d consider moving more money into them from ordinary shares if the stock market hits its recent highs again in the next few months.

The trouble would be that for horizontal diversification purposes, I’d be better buying preference shares from a different bank.

Top candidate would be the Lloyds Banking Group preference shares whose dividends are suspended until 2012. But they look quite a bit riskier to me, plus there’s no dividend for now, plus there’s a bigger spread on buying the shares – plus I’ve already got ordinary Lloyds shares (more on those soon).

This then might be my lot. At the end of the day, the Natwest preference shares are a long way from super secure government bonds, or even bog standard corporate bonds, and a cautious stance seems advisable.

Update: Actually, I’ve now bought and written up the Lloyds preference shares, LLPC, too.

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{ 18 comments… add one }
  • 1 Thomas Jones May 18, 2010, 1:30 pm

    I have a feeling that inflation will be allowed to take grip in order to reduce debt.

    Wage inflation chasing price inflation and price inflation chasing wage inflation.

    The likely VAT increase and whatever else transpires is going to create an interesting equation and surely prices will increase even more and so wages “should” follow.

    It’s the least “politically” painful option but tantamount to juggling with knives.

    Both the country’s and our own debts will appear far more manageable in relation to income – at least that’s the theory 🙂

  • 2 ermine May 18, 2010, 2:31 pm

    You do dig out the most unusual items! The 9% yield looks inviting, though I can’t identify what the catch somewhere in my gut I feel there has to be one.

    I have the same inflation concerns as TJ has, though being debt free means I fear it will destroy my net worth in real terms. I’d be tempted to take out a mortgage again if I could work out what would hold value.

    Thanks for the heads up on some of the more weird and wonderful regions of the stock market!
    .-= ermine on: inflation up to 5.3% in April and has been OTT for seven months in a row =-.

  • 3 The Investor May 18, 2010, 9:25 pm

    @ermine – Yes, I’ve consistently feared inflation too, which is one of the main reasons why I’ve been happy holding so little cash and fixed interest, and to be investing up to the eyeballs in equities and REITS. With the FTSE at 5,800 it seems appropriate not to push my luck, hence the portfolio rebalancing I wrote about, which included the purchase of these prefs. Now the market has fallen back a fair bit (it should open well under 5,300 tomorrow, given what’s happened in the US) I’d probably keep buying shares again!

    Agree re: the mortgage. I’ve said before for me not owning a house has been a decade long mistake. Never a lender or a borrower be – unless all your citizens are borrowers too, in which case better to join the club and get bailed out by HMG! That said, it’s worth noting that inflation was extremely low for most of 2009.

    Re: The Natwest shares, the catch is simple – the bank or its parent could go bust, or perhaps more likely be forced not to pay its coupon for some reason. Even after the recovery, the market thinks this is a non-trivial possibility.

  • 4 The Investor May 18, 2010, 9:29 pm

    @Thomas – I *half* agree. There’s 2.5 million unemployed remember, and public sector wages look very likely to be restrained or even to fall in the next year or two. Most of these inflationary forces at the moment are external or pseudo-one-offs (petrol, the weak pound, the VAT rise which as you rightly say may just be a taster of a second rise to come next month). Raising interest rates in this environment is a bit futile, except in that it would strengthen the pound.

    But yes, I too doubt our new Lords and Masters are losing much sleep over the national debt being made a little less painful just a little faster through inflation right now, though eventually it will show up in the gilt market if it persists – and that *would* worry them!

  • 5 OldPro May 21, 2010, 2:26 pm
  • 6 The Investor May 25, 2010, 9:27 am

    @OldPro – Ha ha, just a coincidence I think. Have to admit it’s nice to see something in my portfolio rising while the markets are falling all around – I was very lucky with that rebalancing timing a few weeks ago, in retrospect.

  • 7 The Investor May 26, 2010, 1:00 pm

    @OldPro – Good spot, I was wondering why NWBD had moved up and I didn’t think it was humble little Monevator!

  • 8 Thomas Jones May 27, 2010, 2:16 pm

    It is possible to have high unemployment (stagnation) and rising prices (inflation) = Stagflation.

    Let’s hope we don’t see it though like in the 1970’s!

  • 9 The Investor May 27, 2010, 8:38 pm

    @Thomas – Yes, it’s interesting how literally everything still seems possible. They’re talking about deflation again in the US, despite all that money printing. Apparently M3 money supply is really tight, due to banks being forced to hold so much capital.

  • 10 Ransom June 10, 2011, 12:36 pm

    Anyone had any luck finding a list of previous dividend payments?

  • 11 Bowlhead99 December 31, 2012, 8:03 pm

    Interesting you put a target price on these of, say, 130p by, say 2015. As of 31/12/12 they are 129p to buy at end of the trading day 🙂

    Obviously there’s a spread below this to get to the sell price, but you found a pretty fine return here – same for the LLPC (and LLPD) you liked. I hold all of them, and think they’ve de-risked somewhat.

    Problem with that de-risking, is the reduced upside potential, no longer quite so compelling – I rather liked getting high returns from what the average person perceived as higher risk and I thought I was reasonable risk.

    I expect I’ll continue to hold the ones I have for a while, but with ‘safe’ government bonds and some blue chip corporate bonds in something of a bubble, are there any more non-equity lucrative investments out there at the moment for my new money? Now the FTSE’s nearly back to 6000 despite the recession, and some emerging markets are flattening if not falling, it’s getting harder and harder to find cheap high quality investments!

  • 12 The Investor January 2, 2013, 11:46 am

    Hi Bowlhead99 — They have indeed done what they said on the tin, and even nicer if you consider we’ve had dividend payments through for the Lloyds ones now, too. 🙂

  • 13 Tronader March 22, 2014, 12:37 pm

    Do you know of any preferred shares screener for UK products by any chance? or how do you discover the available products and the features of the same?

  • 14 Curious Investor April 30, 2014, 4:12 pm

    I’m very confused… it seems these share are now trading at £129!! Is that right or am I showing my ignorance..? My parents bought 3000 of these a few years back and now think they have won the lottery! Is that right or what? Thanks in advance..See here: http://www.marketwatch.com/investing/Stock/NWBD?countrycode=UK

  • 15 Neil May 1, 2014, 9:30 am

    The price is quoted in pence, so £1.29.

  • 16 The Investor May 1, 2014, 9:31 am

    Hi Curious — No, the price is £1.29, sadly it is given in pence like most UK equities and that site has got confused and turned it into pounds. Sorry to disappoint!

    You will never log in to find preference shares have gone up 100-fold, because unlike conventional equities they only pay out a fixed coupon. (As opposed to, say, Amazon shares, which have gone up about 100-times since IPO because its earnings have increased so far and so fast, and theoretically it could pay out a big dividend (though in reality it reinvests all its cash flow.)).

  • 17 Curious Investor May 1, 2014, 11:23 am

    Thanks… I thought it was too good to be true! Annoyed that the Marketwatch site has got something so wrong!

  • 18 The Investor May 1, 2014, 12:24 pm

    I know, but all free data providers get some things wrong. In fact even my main data provider (which would cost you thousands of pounds a year in annual subscription fees) gets things wrong from time to time.

    Best thing to do is double check! 🙂 Also you get used to the quirks. This £/pence one is a common mistake. Another one to look out for is the data provider thinking that one off special-dividends are the new sustainable rate (or vice-versa).

    Some quotes can be distorted by wide bid/offers — Google Finance is a classic one to beware of here.

    Hope this helps. Sorry your parents haven’t made a bundle.

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