RY.PR.R Not As Good As Expected On Good Volume

Royal Bank of Canada has announced:

it has closed its domestic public offering of Non-Cumulative, 5-Year Rate Reset Preferred Shares Series BM. Royal Bank of Canada issued 30 million Preferred Shares Series BM at a price of $25 per share to raise gross proceeds of $750 million.

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

The Preferred Shares Series BM were issued under a prospectus supplement dated February 29, 2016 to the bank’s short form base shelf prospectus dated January 21, 2016.

RY.PR.R is a FixedReset, 5.50%+480, announced 2016-2-25. The issue will be tracked by HIMIPref™ and assigned to the FixedReset subindex.

The issue traded 1,482,632 shares today (consolidated exchanges) in a range of 25.15-27 before closing at 25.23-25, 25×70. The TXPL total return index has increased by 830bp since the announcement date, so buyers on new-issue day could have done better elsewhere!

Vital statistics are:

Maturity Type : Call
Maturity Date : 2021-08-24
Maturity Price : 25.00
Evaluated at bid price : 25.23
Bid-YTW : 5.34 %

Implied volatility analysis indicates the issue is expensive at its current level:

Click for Big

Interpretation of this chart using the standard assumptions that everything will remain the same forever leads us to believe that the new issue is a little cheap – fair value is $25.48 according to the best fit of the NVCC-compliant issues, compared to an actual bid of 25.23. Note that RY.PR.Q is indicated to be quite expensive: it resets at 453bp (less than RY.PR.R) on 2021-5-24, and is 0.71 rich at its bid of 25.52 (higher than RY.PR.R).

However, the standard assumptions are even more shaky than they usually are. Some will say that the derived value of Implied Volatility, at 24%, is far too high and may be expected to decline in the future. This will cause the theoretical curve to flatten, which implies that the higher-spread issues will outperform the lower spread issues. Some will say, however, that the fundamental assumption of non-directionality in the Black-Scholes theory is wrong; that spreads in general are far too high, will narrow, and therefore the lower-spread issues will outperform the higher-spread issues. Some, like myself, will say that both criticisms are correct but that on balance the lower-spread issues are preferable. If, for instance, you plug in a 250bp spread and 10% Implied Volatility – numbers I would consider more reflective of a normal market – you find that the four lower spread issues increase in price by over 40%, compared to the higher-spread issues, which may well go substantially above the $25 call price, but not 40% worth. Mind you, the critical part of the above analysis is “normal” … i.e., with five year Canadas yielding more than inflation and that’s just for starters! There will be some who believe that current conditions represent the new normal; these players will probably prefer the higher-spread issues.

3 Responses to “RY.PR.R Not As Good As Expected On Good Volume”

  1. Louisprefs says:

    Hello James,

    In the good (not so) “old” days, when straight prefs were the majority of outstanding issues and before the OFSI came in with stricter rules on Tier 1 capital, you used to calculate after each Canadian bank results the room they had to issue new prefs. I don’t want to burden you with that but I am just curious as to why you are no longer calculating that. Is that it is no longer meaningful or cannot be done anymore?

    As you may have gathered from my other posts, I am concerned by the Canadian banks new fix reset issuances under terms (+450 bps and more) I find overly generous thus destroying the secondary market for the earlier issues of the last 4 years or so. Whilst BNS and RY have been issuing repeated huge issues of those (the “5.5 market killers” I call them) lately, BMO and CM have kept quiet and more new issues of those could come from NA and TD.

    I would feel more comfortable trading on the secondary market if a knew that the new inflow of those is nearing the end.

    Best rgds

  2. Louisprefs says:

    … And just as I was finishing writing the above, LB is coming in with a 5.85% issue with, I assume, +525 bps or more as reset formula…

  3. adrian2 says:

    Not to be outdone, CWB is coming out with a 6.25% +547 bps new issue.

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