RY.PR.F & RY.PR.W & the Swoon in June

Just doing a little playing around … and thinking of today’s market commentary … and I thought I’d post a few graphs regarding these two issues, taking data from the last approximate trough of November 30, 2007 until now.

“Disparity” is a proprietary HIMIPref™ measure of rich/cheap. It is not the same thing as valuation … but it is very influential in this calculation. It should be noted that in the above graphs, the disparity is calculated according to the pre-tax yield curve, which I never use for valuation purposes. So caveat lector … just enjoy the trends!

Update: See also previous post for RY.PR.F.

15 Responses to “RY.PR.F & RY.PR.W & the Swoon in June”

  1. prefhound says:

    I shall rise to the bait.

    I looked at the 2008 price and yield history of the RY straight prefs with the following conclusions:

    1. The slope of yield vs $dividend varies a lot more than for CIBC. It is most often close to zero or slightly positive (James expects slightly positive; but this is less positive than CIBC). The RY slopes may be affected by lower $Dividends than CIBC and by the Apr/08 issue of RY.PR.H. This slope has also been negative (as it is now) several times before, with quick snap backs. The correlation between the slope and the mid-point yield is low (0.13), unlike CIBC.

    2. The Arb trade is to short RY.PR.W and buy the cheaper of RY.PR.A or F (with Pr.A being about twice as liquid in 2008). I estimate RY.PR.W is overvalued by $1.42 or $1.12 after arb costs and may be worthwhile at a minimum of 1000 shares.

    We shall see what Monday brings!

  2. […] PrefBlog Canadian Preferred Shares – Data and Discussion « RY.PR.F & RY.PR.W & the Swoon in June […]

  3. prefhound says:

    OK, I’m in at a short of RY.PR.W at $22.22; long RY.PR.F at $18.77 with the expectation of a $1.37 over-valuation of the W. My short didn’t seem to help Pref W go down, but my buy seems to have boosted Pref F to 1 pm today. Will let you know when I close. My hope is to use the profits to renew my Pref Letter subscription! Double the value from prefblog!

  4. jiHymas says:

    Woo-hoo! prefhound, you are a player!

  5. prefhound says:

    I’ve done some more research on the CM.PR.E and RY.PR.W which gives us something to hang the apparent market mispricing on:

    Both of these are covertible at the bank’s option into common shares. In the case of CIBC the date is any time after Oct 31, 2008 and in the case of RY, the date is Feb 24, 2010 or later.

    IF banks were to convert, pref holders would receive common equity worth about $26.315 before costs — well above the current trading prices of these prefs in the $22+ range.

    Of course, prefblog uses Yield-to-Worst and treats these two issues like discount prefs. The argument for this is that the banks are unlikely to force conversion for a host of reasons — unless they can’t raise money by any other method.

    However, in these times of stress, and with the CIBC date coming up in only 4 months, it is not inconceivable they could be converted by the bank (though I have to note CM.PR.E has already erased 75% of its over-valuedness by 11:20 am today). Thus, the apparently misaligned prices of $1 or more COULD represent a kind of call option on the possibility the bank will convert. If so, market prices of June 30 would have indicated about a 20% chance of CIBC converting and nearly 30% for Royal.

    What is weird, then, is that this option had next to no value for most of the year, and suddenly bloomed to $1+ in June. For us arbs, this option value is difficult to hedge, and by shorting RY.PR.W to buy RY.PR.F we actually end up with net credit exposure to Royal Bank (If RY goes in the tank and is desperate for capital, the PR.W will keep some value, while the PR.F will tank much more severely).

    So much for incomplete research…. 😉

  6. jiHymas says:

    I’m not sure that I follow this reasoning.

    Converting the RY.PR.W into shares (using the cash redemption price as the numerator and the greater of 95% of market and $2.50 as the denominator) will not change the bank’s tier 1 capital – it’s already tier 1. What such a course might possibly do is save the bank some dividend payments, in the event that the common dividend has been halted and the preferred dividend hasn’t been. It might also free up some room for preferred issuance if some is needed.

    We can agree that the option for the bank is there, but the holder is short the option; it cannot increase the value of RY.PR.W, if it has any effect at all it must be to decrease it.

    I find it difficult to believe the option has any value at all; I suspect that it will not be possible to assign a value to it that will be in any way consistent with market prices of regular options.

  7. prefhound says:

    RY common has a current yield of 4.4% and CIBC common yields 6.2%. At a conversion event, the yield of RY.PR.W would be 4.7% and CM.PR.E would be 5.3%, so CIBC would actually pay more in dividends (without a common dividend cut) if converted.

    Another argument is that costs to the bank could be lower to convert rather than issue new common (or prefs). If these costs were combined with some dividend savings, the bank’s likelihood to exercise its option might increase.

    I am not sure your argument that “.. the holder is short the option; it cannot increase the value of RY.PR.W..” is true. The conversion option for the bank is like a long call on the pref, but paying with a variable amount of stock has some characteristics of a short put on RY assets — more dilution the lower RY common is at the time of exercise. Even though the bank’s short put is conditional on the bank’s long call, perhaps there could be positive value to the pref owner who has the opposite side.

    This is not a standard option because the pref is different from the common and the conversion ratio is not established until the bank’s conversion privilige is exercised. The fact that the outcome could be positive to the pref holder (while Price is less than any call) and the probability of exercise is even infinitesimaly larger than zero means that it should have a non-zero value to the pref holder.

    Anyway, I like your Tier 1 argument better….Laurentian already has an option it could exercise (LB.PR.D), and a relatively weaker common/pref equity ratio, but has shown no interest in conversion.

    Meanwhile, I am sitting on my RY Arb and not rueing my incomplete diligence.

  8. […] are some surprising strangenesses in prices as of the close today. For instance, remember the RY.PR.W / RY.PR.F inversion? At today’s closing bid of 20.27, RY.PR.W yields 6.16% while RY.PR.F yields 6.21% at $18.26. […]

  9. Lex says:

    As I read this blog I am watching the Arb for RY.pr.W in the exact reverse of what Prefhound was doing back in 2008 but this time you get to buy the W and Short almost any other RY pref. I prefer to short those that are over $25 because I think people have a psychological issue about a capital loss and typically the perpetual prefs seem to hover there so I chose the B. With the B moving 80k shares today at $25.05 for a 4.69% return (less a small capital loss on eventual redemption) and the W at 24.80 yielding a 4.96% current yield (with a small capital gain on eventual redemption), the current yield spread in my humble opinion is absurd. I am expecting a 3% ROI in 1-90 days when people figure this out. Hooray for market efficiency!

  10. jiHymas says:

    A problem with RY.PR.W is that it is exchangeable for common at the bank’s option: RY therefore has the ability to create a “synthetic NVCC clause” similarly to CIBC’s machinations and thereby make it officially a PerpetualDiscount, as opposed to the DeemedRetractible status of the other RY Straight issues.

  11. Lex says:

    Yes NCVV issue, but it seems to me that all historical RY pref perpetual discounts have been redeemed typically on at their final redemtion options (although history is no indication of the future I would bet these get redeemed around Feb,2014). Their option to convert to common actually would be welcomed by the arbitrager although unlikely (I can’t think of many situations that would happen that would make them do that). When I look at the spread I don’t think a redemtion in 10 yrs is the basis for the yield spread, just too far away with so many uncertainties. If I had to hold on for more than 120 days, I would be rethinking the entire Arb. I suspect the B will bounce around the $25 mark as will the W but the W gives a larger yield while waiting for the spread to go the otehr way. Time will tell.

  12. Lex says:

    I forgot to mention, great blog! Best place on the web for Canadian pref info for certain.

  13. jiHymas says:

    Flattery will get you everywhere!

  14. fsabbagh says:

    Any idea why this preferred is tanking? It’s really starting to make me wonder if something is up. Any thoughts?

  15. jiHymas says:

    For a review of the recent market downdraft, see the post eMail To A Client. This post was written in late July, but remains applicable.

    Note that the two issues headlined in this post have become a little bit different as a result of the NVCC rules: RY.PR.W is exchangeable for common at the option of the company and it is therefore prudent to regard it as NVCC-compliant due to possibility of the company pursuing the option that led to CM.PR.D, CM.PR.E, CM.PR.G: NVCC Status Confirmed

    RY.PR.F is NVCC Non-Compliant and is therefore considered very likely to be redeemed on or prior to 2022-1-31 since by that time it will no longer be eligible for inclusion in the bank’s Tier 1 Capital.

    Today’s YTW for RY.PR.W is actually pretty low, at 5.07% compared to today‘s index average of 5.52%. According to me, that makes it about $2.00 over-priced!

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