BMO.PR.E Firm on Excellent Volume

Bank of Montreal has announced:

it has closed its domestic public offering of Non-Cumulative 5-Year Rate Reset Class B Preferred Shares Series 44 (Non-Viability Contingent Capital (NVCC)) (the “Preferred Shares Series 44”). The offering was underwritten on a bought-deal basis by a syndicate of underwriters led by BMO Capital Markets. Bank of Montreal issued 16 million Preferred Shares Series 44 (which includes Preferred Shares Series 44 issued pursuant to the exercise in full of an underwriters’ option to acquire up to 4,000,000 Preferred Shares Series 44 as part of the offering) at a price of $25.00 per share to raise gross proceeds of $400 million.

The Preferred Shares Series 44 were issued under a prospectus supplement dated September 10, 2018, to the Bank’s short form base shelf prospectus dated May 23, 2018. Such shares will commence trading on the Toronto Stock Exchange today under the ticker symbol BMO.PR.E.

BMO.PR.E is a FixedReset, 4.85%+268, announced 2018-09-06. It will be tracked by HIMIPref™ and has been assigned to the FixedReset Discount subindex.

The issue traded 1,362,183 shares today in a range of 24.90-99 before closing at 24.98-00. Vital statistics are:

BMO.PR.E FixedReset Disc YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2048-09-17
Maturity Price : 23.14
Evaluated at bid price : 24.98
Bid-YTW : 4.83 %

The new issue is quite expensive according to Implied Volatility Analysis:

impvol_bmo_180917
Click for Big

According to this analysis, the fair value of the new issue on September 17 is 24.15.

The ludicrously high figure of Implied Volatility is something I take to mean that the underlying assumption of the Black-Scholes model, that of no directionality of prices, is not accepted by the market; the market seems to be taking the view that since things seem rosy now, they will always be rosy and everything will trade near par in the future.

I balk at ascribing a 100% probability to the ‘all issues will be called, or at least exhibit price stability’ hypothesis. There may still be a few old geezers amongst the Assiduous Readers of this blog who can still (faintly) remember the Great Bear Market of 2014-16, in which quite a few similar assumptions made earlier turned out to be slightly inaccurate. The extra cushion implied by an Issue Reset Spread that is well over the market spread is worth something, even if nothing gets called.

Or, to put it another way, one can buy a whole lot of downside protection for very little extra money, relative to this issue. For instance, BMO.PR.D, FixedReset, 4.40%+317, is bid at 25.10 (theoretical fair value of 25.28, according to the above analysis, which ignores the interim dividend shortfall). You’re giving up about $0.10 p.a. in dividends until it resets 2022-8-25, sure, but you’re getting a significant amount of protection in the event of a market downturn, and more dividend afterwards if not called. Is it worth it? Well, that will depend a lot on your aversion to loss … I’m just saying that buying the same amount of protection costs more in most other series of FixedResets.

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