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 [1].
I bought some Natwest preference shares using the cash I raised [2] 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 [3].
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 [4] by buying these Natwest preference shares [5].
(The rest of my free cash? Some went back into shares made cheaper by the Euro wobbles [6]. 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 [7] 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 [8] 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 [9] 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’ [10]. 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 [11]. 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 [12]? 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 [13] 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 [14] 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 [5] are a long way from super secure government bonds, or even bog standard corporate bonds [15], and a cautious stance [16] seems advisable.
Update: Actually, I’ve now bought and written up the Lloyds preference shares, LLPC [17], too.