Bearbull's alarm clock wasn’t set early for NatWest’s (NWG) results on 16 February.
Sure, the Farage de-banking set-to and subsequent CEO harakiri have lately added spice to this usually humdrum retail banking story. But beyond that drama, it’s all been a bit more prosaic. Stil, the optimist who cracked open the RNS feed at 7am will have been rewarded with news of the company's strongest pre-tax profits since the financial crisis.
Although its loan-to-deposit ratio crept higher, NatWest’s net interest margin climbed, and a final dividend of 11.5p pushed the full-year payout 26 per cent higher. On balance, not bad. Although, in this case, somewhat moot.
The source of this complacency lies in the nature of my stake. As a holder of National Westminster Bank (NWBD) perpetual 9 per cent non-cumulative preference shares, my concerns are roughly limited to two areas. The first is the avoidance of the kind of group-wide calamity or bank run that tends not to respect pre-diarised earnings releases. Second is the sudden appearance of some legal finagling fine-print that could see the quasi-equity, quasi-bond squeezed. Again, this year’s annual report was mercifully free of that threat.
The genesis of the NatWest prefs in the portfolio dates to late 2012. With both the 2007-08 financial and eurozone debt crises receding in the rearview mirror, the prospect of a major banking blow-up had started to recede. That didn’t make UK bank equities enticing, as years of regulatory sanctions, fines and withering returns on equity would prove. Nor, in the case of what was then RBS, would its shares have cleared the first hurdle for inclusion in the Bearbull Income Portfolio. As a recently adopted ward of the state, its return to the dividend list was still six years away.
But flying beneath many investors’ radars were the preferences shares of large UK financial institutions, issued in an era when they offered a cheap source of capital. In the case of NatWest prefs, their origin dates to September 1991, and three years into double-digit interest Bank of England base rates. With bond markets asking for an even bloodier pound of flesh, the discovery of willing buyers for £140mn of stock yielding 9 per cent in perpetuity was considered a deal.
Despite the force of the latest hiking cycle, borrowing costs have never come close to those seen in the early 1990s. Because of this, the prefs have occupied a big role in the portfolios of many UK income seekers, a status that was cemented after their coupons survived the RBS bailout thanks to their linkage to the performance of the retail banking arm.
The last major event occurred in June 2021, when the bank made a tender offer for the shares at 175p. The uptake, from institutional and retail investors alike, was unsurprisingly low, given the offer’s 5.14 per cent implied yield. Still, today the shares trade a quarter lower, at 131p.
Almost three years, a nasty episode of inflation and a 5-plus per cent bump in the risk-free rate later, and the question remains as to whether that tender was a missed opportunity. Although I’m still not entirely clear why NatWest chose that peak to make its offer, beyond a benign backdrop for lending risk and a build-up of cash following the pandemic bank dividend ban, neither am I too regretful.
Yes, hindsight is more than capable of reaching back into 2021 and selecting some juicy replacement income stocks. But even with a crystal ball, the price would likely be more risk. And that’s important, because the enduring attraction of the prefs is the unusual risk-reward balance they provide many historic buyers. Although the security carries some features of a bond, including the gravitational pull of its par price, the combo of high yield and perpetuity is hard to beat. My holding, despite posting a mere 10 per cent capital gain over 11 years, is close to having paid for itself in dividends, given they were acquired when the shares were yielding 7.4 per cent.
That’s the slightly rose-tinted view, mind. Since adding the shares, inflation has dented the value of both my initial capital outlay and those twice-a-year distributions, to the tune of 27 per cent. I’ve made the point before with fellow income portfolio stock, Real Estate Credit Investments (RECI), whose flatlining dividend has landed in my brokerage account dutifully and to increasingly diminished effect every quarter for almost seven years. The lesson: one should never overlook the vanity of a smart initial trade whose pay-off lessens with inflation’s slow creep.
To date, the NatWest prefs have produced a far superior return to the banking group’s equity. However, in a return to the natural order of things, the ordinary shares’ dividend yield is now ahead. While they carry a lot more risk and no guarantees, they do offer the possibility of inflation-beating growth. If my prefs’ income is to grow, I’ll need to grow the position. A decision awaits.
