PrefBlog

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:

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:

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.

Some will recall that Muddy Waters / Carson Block have shorted Manulife shares in a move that looks prescient regardless of the details:

Muddy Waters has found its latest target: Canadian insurer Manulife Financial Corp.

Short seller Carson Block, who runs Muddy Waters, announced a short position in the firm Thursday, and said its life-insurance subsidiary just concluded a trial with a hedge fund that could lead to billions in losses. Block expects a verdict this year. Manulife said in a statement that it disagrees with Block’s conclusions.

In a report, Muddy Waters said it believes investors aren’t aware of the material risks to Manulife posed by the trial. The insurer was taken to court by hedge fund Mosten Investment LP, which claims it should be allowed to deposit unlimited amounts of capital with Manulife and earn at least 4 per cent in annual interest based on a 1997 universal life insurance policy it owns.

The trial concluded recently:

In an era of higher interest rates in the late 1990s, two predecessor companies of Industrial Alliance Insurance and Financial Services Inc. and Manulife Financial Corp. issued life insurance policies that allowed holders to invest in side accounts that guaranteed rates of up to five per cent and four per cent, respectively.

These side accounts did not contain an explicit limit on the size of investment, which means in today’s low-rate environment they are potentially lucrative for their holders and a significant liability for the companies that wrote them.

At least three limited partnerships purchased such policies several years ago in Saskatchewan, one of only four Canadian provinces that permit the purchase of insurance policies from their original holders. These investors are in court in Saskatoon to force the insurers to accept their money.

So it looks potentially dangerous, eh? But Manulife was defiant:

The Muddy Waters report is a short seller’s attempt to profit at the expense of our shareholders, and we disagree with its conclusions. Manulife continues to believe that Mosten’s position is legally unfounded. We firmly believe that the consumers purchasing universal life policies, and the insurers issuing these policies, never intended to have the policies function as deposit or securities contracts. We have a sound, highly rated global franchise. We expect we will prevail with respect to this matter and that it will not affect our business operations or our ability to meet obligations to our customers, vendors and other key stakeholders.

… as were others:

Industrial Alliance Insurance and Financial Services Inc. (iA Financial Group) is responding to media reports regarding litigation involving Ituna Investment LP (Ituna). As part of this litigation, Ituna is seeking to make unlimited deposits into a universal life insurance contract that it purchased from a policyholder. The life insurance contract was originally issued by National Life, a company acquired by iA Financial Group in 1988.

The application was heard by the Court of Queen’s Bench in Saskatoon (Saskatchewan) in September 2018 and the parties now await the court’s decision.

iA Financial Group believes that the position taken by Ituna is legally unfounded. Ituna’s position would result in life insurance contracts being used as deposit accounts or commercial paper, purposes that are unrelated to life insurance and for which they were never intended. Ituna’s interpretation is contrary to the language of the life insurance contract and the legislative framework that governs insurance in Canada. iA Financial Group believes its legal position in this matter is strong and expects that it will be successful in its defence.

But remember – this is Canada! Future employment possibilities for ex-regulators are limited and must be cherished, as we found out in 2008 when Manulife’s grossly incompetent investment strategy nearly left it bust:

On Sept. 30, the head of Canada’s regulator, the Office of the Superintendent of Financial Institutions, wrote an e-mail to various OSFI officials. “D’Alessandro just called and asked that we try to meet next week with the company to discuss capital,” Julie Dickson wrote, noting that the meeting would replace one that had been arranged for November. Mr. D’Alessandro wanted to discuss the capital requirements for the variable-annuity, or segregated funds, business, other e-mails show.

Discussions took place in October in which he laid out why he felt the rules were too onerous, and OSFI officials had a flurry of internal discussions. On Oct. 28, the rules were changed.

OSFI consulted with more than one insurer that month, but the changes were most important to Manulife.

Federal lobbyist records show that Mr. D’Alessandro also met with Prime Minister Stephen Harper on Nov. 6 to discuss “financial institutions.” It is not known what was discussed at the meeting with Mr. D’Alessandro.

So now the cavalry has arrived again!

A trio of lawsuits against three Canadian life insurers face new hurdles after the government of Saskatchewan updated its insurance regulations, instituting changes that could materially impact the ongoing court cases – as well as a short seller’s high-profile campaign against Manulife Financial Corp.
…
All parties are waiting for the judge to rule, and the decision is expected to take some time to come out. But late Monday the government of Saskatchewan added a new dimension to the litigation by updating its insurance regulations, inserting new language that limits how much money can be deposited in insurance policies and their related accounts.

Manulife’s share price rose about 6 per cent on the Toronto Stock Exchange in early trading on Tuesday.

In an amendment to the Saskatchewan Insurance Regulations, the province added new language that states “no licensed insurer shall receive or accept for deposit funds or payments in excess of the amount required to pay the life insurance premium for the eligible period.”

Manulife crows:

The Saskatchewan regulations, published yesterday on the website of the Financial and Consumer Affairs Authority of Saskatchewan, limit the amount of premiums a life insurer may receive or accept for deposit in life insurance policies and associated side accounts. The basis of the claims by Mosten Investment LP (“Mosten”) against Manulife has been that life insurers can be compelled to accept unlimited premium payments. In effect, Mosten is seeking to use insurance policies to invest sizeable sums that have no connection to the insurance coverage.
…
Given the new Saskatchewan regulations, Manulife and the other life insurers involved in similar matters plan to make submissions to the court, asking it to dismiss the claims that life insurers can be compelled to accept unlimited premium payments. Manulife believes these regulations should accelerate the resolution, in its favour, of the principal matters in the Mosten litigation in Saskatchewan. With respect to any possible remaining ancillary matters in the litigation, Manulife continues to believe that it will prevail and that those matters are insignificant in any event.

Because the public policy concern addressed in Saskatchewan is equally relevant across Canada, the Canadian Life and Health Insurance Association, which intervened in the litigation on behalf of the industry, plans to request other provincial and territorial governments to take comparable regulatory steps to avoid unnecessary, costly litigation in other jurisdictions.

… and, of course, other potential future employers of regulatory personnel voiced their support:

Industrial Alliance Insurance and Financial Services Inc. (iA Financial Group) welcomes the recent publication of Saskatchewan regulations limiting the amount of premiums a life insurer may receive or accept for deposit in life insurance policies and associated side accounts.

Explicitly affected issues are (other lifecos may have been affected by this as well):

MFC.PR.B, MFC.PR.C, MFC.PR.F, MFC.PR.G, MFC.PR.H, MFC.PR.I, MFC.PR.J, MFC.PR.K, MFC.PR.L, MFC.PR.M, MFC.PR.N, MFC.PR.O, MFC.PR.P, MFC.PR.Q and MFC.PR.R

IAG.PR.A, IAG.PR.G and IAG.PR.I