RY.PR.S Surprisingly Strong on Modest Volume

Royal Bank of Canada has announced (on November 2):

it has closed its domestic public offering of Non-Cumulative, 5-Year Rate Reset Preferred Shares Series BO. Royal Bank of Canada issued 14 million Preferred Shares Series BO at a price of $25.00 per share to raise gross proceeds of $350 million.

The offering was underwritten by a syndicate led by RBC Capital Markets. The Preferred Shares Series BO will commence trading on the Toronto Stock Exchange today under the ticker symbol RY.PR.S.

The Preferred Shares Series BO were issued under a prospectus supplement dated October 29, 2018 to the bank’s short form base shelf prospectus dated January 30, 2018.

RY.PR.S is a FixedReset, 4.80+238, announced 2018-10-25. It will be tracked by HIMIPref™ and has been assigned to the Fixed-Resets (Discount) subindex.

RY.PR.S traded 747,100 shares on its November 2 opening date in a range of 24.50-75 before closing at 24.70-75. Vital statistics (on November 2) were:

RY.PR.S FixedReset Disc YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2048-11-02
Maturity Price : 23.04
Evaluated at bid price : 24.70
Bid-YTW : 4.74 %

Given that the FixedReset (Discount) index to which it is assigned lost 2.51% between the October 25 announcement date and the November 2 closing date, the 24.70 bid is actually pretty good!

The new issue is so ridiculously expensive that we don’t even need fancy-pants Implied Volatility Analysis to prove it, but here’s the chart anyway:

impvol_ry_181105
Click for Big

According to this analysis, the fair value of the new issue on November 5 is 22.61, down $1.16 from the October 26 estimate of 23.77.

But, as I say, we don’t need this – even though the issue is, amusingly, trading more in line with NVCC non-compliant issues than the compliant ones. Let’s look at RY.PR.H, a FixedReset, 3.90%+226, that commenced trading 2014-6-3 after being announced 2014-5-23. This issue resets 2019-8-24, which is only three dividends away. The total dividend difference between RY.PR.H and RY.PR.S until then is therefore (4.80% – 3.90%) * 25 * 3/4 = $0.17. So for a reasonable comparison, take the actual November 5 bid of 22.20 for RY.PR.H and add seventeen cents to it to reflect the dividend difference. RY.PR.H has a projected dividend of (GOC5 + IRS) * 25 = (2.44% + 2.26%) * 25 = 4.70% * 25 = 1.175 p.a., which, at a notional price of 22.37, gives us an Expected Future Current Yield of 5.25%.

At the current bid of 24.69 and an expected future dividend of 1.205, RY.PR.S has an Expected Future Current Yield of 4.88%. Need I say more?

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.

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