Analysis & Comment:  

As the holders of many banking preference shares are no doubt aware, the EU has placed a moratorium on the payment of discretionary coupons for those banks which are in receipt of state aid.  The ruling was not unreasonable, but it was certainly a blow to the holders of these securities, who will have to tighten their belts for a few years until the state aid is withdrawn and the coupon payments can be re-started.

However, with preference shares, as in life, not all securities are equal. Certain issues are continuing to pay coupons. This is generally due to the fine detail of the legal obligations of the issuer as set out in the prospectus and is more likely to occur in older issues where the "language" of the prospectus tends to be slightly more investor-friendly.  Such issues, where the coupon continues to be paid are known as "must pays" in the market. The assumption is that given that these securities have managed to make it through one of the most extreme situations that the banking industry has ever faced with their coupon payments intact, they should be OK going forward. This is certainly logical, but on the flip side, I must point out that assumptions can be quite dangerous things, particularly in the financial markets!

Thus, this week’s Bond of the week is not actually a bond, it is the National Westminster 9% irredeemable preference share, one of the aforementioned "must pay" preferences.

In the halcyon days of the early part of the last decade, these preference shares traded in the range 140-160p in the pound. That equated to a running yield of 6.4% - 6%, suggesting that investors were fairly complacent with regard to risk. The credit crunch saw the rug pulled and in early 2009, the securities could be picked up for about 40p in the pound. The subsequent rally, which appears to be still underway, saw the securities trade up to around 90p by the end of 2009. The current market price lies around 98 - 102.5p.  At the offer price of 102.5, that’s a running yield of just under 8.8%.

A few facts about this security:

• Issued by Natwest, now owned by RBS.
• Launched in 1991 at £1.00: 140 million shares.
• 9% coupon, payable semi-annually. Non-cumulative.
• Minimum denomination £1.
• Perpetual, non-callable.
• ISIN Code GB0006227051, LSE code NWBD.
• Rated BB- by Standard & Poor’s (sub investment grade).

My view: I like this asset and I intend to purchase a holding for the www.fixedincomeinvestor.co.uk portfolio. An 8.8% running yield will be very welcome, and the non-call feature gives upside potential. However, some caution should be applied. The risk presented by deeply subordinated instruments in the banking sector is "real and present" in the current economic environment. Having caught a cold on an oversized position in Bradford & Bingley PIBS a couple of years ago, I will restrict purchase of this type of paper to "half sized" positions. For my portfolio, that’s an investment of £5,000.

Note: a sharp-eyed reader has pointed out to me that the Natwest prefs trade "dirty". That means that the price has the accrued rolled up into it. Given that there is maybe 3/4 of a point of "accrued" built into the price, the running yield I have quoted is a slight understatement.

Mark Glowrey