Bank of Montreal has announced:
a domestic public offering of $300 million 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 will be underwritten on a bought-deal basis by a syndicate of underwriters led by BMO Capital Markets. The Bank has granted to the underwriters an option to purchase up to an additional $100 million of the Preferred Shares Series 44 exercisable at any time up to 48 hours before closing.
The Preferred Shares Series 44 will be issued to the public at a price of $25.00 per share. Holders will be entitled to receive non-cumulative preferential fixed quarterly dividends for the initial period to November 25, 2023, as and when declared by the Board of Directors of the Bank, payable in the amount of $0.303125 per share, to yield 4.85 per cent annually.
Subject to regulatory approval, on November 25, 2023 and on November 25 of every fifth year thereafter, the Bank may redeem the Preferred Shares Series 44 in whole or in part at par. On November 25, 2023, the dividend rate will reset and will reset thereafter every five years to be equal to the 5-Year Government of Canada Bond Yield plus 2.68 per cent. Subject to certain conditions, holders may elect to convert any or all of their Preferred Shares Series 44 into an equal number of Non-Cumulative Floating Rate Class B Preferred Shares Series 45 (Non-Viability Contingent Capital (NVCC)) (“Preferred Shares Series 45”) on November 25, 2023, and on November 25 of every fifth year thereafter. Holders of the Preferred Shares Series 45 will be entitled to receive non-cumulative preferential floating rate quarterly dividends, as and when declared by the Board of Directors of the Bank, equal to the then 3-month Government of Canada Treasury Bill Yield plus 2.68 per cent. Subject to certain conditions, holders may elect to convert any or all of their Preferred Shares Series 45 into an equal number of Preferred Shares Series 44 on November 25, 2028, and on November 25 of every fifth year thereafter.
The anticipated closing date is September 17, 2018. The net proceeds from the offering will be used by the Bank for general banking purposes.
The new issue is quite expensive according to Implied Volatility Analysis:
Click for Big
According to this analysis, the fair value of the new issue on September 6 is 24.22.
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 25.13 (theoretical fair value of 25.33, 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. 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.
Thanks very much James!
Hi James
Typo last paragraph? Does not BMO.D reset in 2022-8-25.
Oops! Yes broke, you are quite right. I’ve fixed it.
I think both issues are attractive and to me the new issue isn’t all that expensive.
If I don’t consider the risk of an issue being called instead of resetting to a new rate then BMO D looks like a better buy. But I would also try and factor in what I consider the significantly increased chance that BMO D would be called. Not that I have a formula for calculating this risk, but it is something I always consider.
Since I try and mitigate the risk on large changes in interest rates, I would consider buying both issues if I was in the market for buying more prefs.