AIM.PR.A & FFH.PR.E: Convert Or Hold?

It will be recalled that AIM.PR.A will reset to 4.50% and that FFH.PR.E will reset to 2.91% effective March 31.

Holders of both securities have the option to convert to FloatingResets, which will pay 3-month bills plus 375bp and plus 291bp, respectively. Deadlines for notifying the company of the intent to convert are March 17 and March 16, respectively; note that these are company deadlines and that brokers will generally set their deadlines a day or two in advance, so there’s not much time to lose if you’re planning to convert!

The most logical way to analyze the question of whether or not to convert is through the theory of Preferred Pairs, for which a calculator is available. Briefly, a Strong Pair is defined as a pair of securities that can be interconverted in the future (e.g., AIM.PR.A and the FloatingReset that will exist if enough holders convert). Since they will be interconvertible on this future date, it may be assumed that they will be priced identically on this date (if they aren’t then holders will simply convert en masse to the higher-priced issue). And since they will be priced identically on a given date in the future, any current difference in price must be offset by expectations of an equal and opposite value of dividends to be received in the interim. And since the dividend rate on one element of the pair is both fixed and known, the implied average rate of the other, floating rate, instrument can be determined. Finally, we say, we may compare these average rates and take a view regarding the actual future course of that rate relative to the implied rate, which will provide us with guidance on which element of the pair is likely to outperform the other until the next interconversion date, at which time the process will be repeated.

To this end, we may construct a table showing similar pairs currently trading:

Fixed Reset Fixed Rate Floating Reset Spread over Bills Bid Price
Fixed Reset
Bid Price
Floating Reset
Break-Even 3-Month Bill Rate
Investment Grade
BNS.PR.P 3.35% BNS.PR.A 205 25.31 24.60 0.30%
TD.PR.S 3.371% TD.PR.T 160 25.24 23.90 0.01%
BMO.PR.M 3.39% BMO.PR.R 165 25.20 24.00 0.19%
BNS.PR.Q 3.61% BNS.PR.B 170 25.47 23.86 -0.09%
TD.PR.Y 3.5595% TD.PR.Z 168 25.42 23.85 -0.06%
BNS.PR.R 3.83% BNS.PR.C 188 25.65 24.11 0.13%
RY.PR.I 3.52% RY.PR.K 193 25.39 24.10 0.11%
TRP.PR.A 3.266% TRP.PR.F 192 20.17 18.75 -0.06%
DC.PR.B 5.688% DC.PR.D 410 25.12 22.11 -1.73%
AZP.PR.B 5.57% AZP.PR.C 418 13.48 12.75 0.48%
FFH.PR.C 4.578% FFH.PR.D 315 23.15 21.00 -0.78%

We can show this graphically by plotting the implied average 3-month bill rate against the next Exchange Date (which is the date to which the average will be calculated).

Click for Big

The market appears to have a profound distaste at the moment for floating rate product; the implied rates until the next interconversion are all lower than the current 3-month bill rate and many are negative! While a negative average bill yield over the next 4-5 years is not impossible, I suggest that it’s very unlikely, leading to the conclusion that, as a group, FloatingResets are currently cheap relative to their FixedReset counterparts (since FloatingResets’ total return will be greater if the actual average exceeds the implied average).

Since credit quality of each element of the pair is equal to the other element, it should not make any difference whether the pair examined is investment-grade or junk, although we might expect greater variation of implied rates between junk issues on grounds of lower liquidity. The average in the table above for the junk issues is about -0.70%; for the investment grade issues it is about 0.10%. If we plug in these implied yields and the current bid prices of the FixedResets, we may construct the following table showing consistent prices for the two pairs under consideration:

Estimate of FloatingReset Trading Price In Current Conditionss
  Assumed FloatingReset
Price if Implied Bill
is equal to
FixedReset Bid Price Spread -0.70% +0.10%
AIM.PR.A 20.51 375bp 19.07 19.87
FFH.PR.E 15.00 216bp 13.53 14.34

Based on current market conditions, I suggest that the FloatingResets that may result from conversion of AIM.PR.A and FFH.PR.E will be cheap and trading considerably below the price of the continuing FixedResets. Therefore, I recommend that holders of AIM.PR.A and FFH.PR.E continue to hold these issues and not to convert. I will note that, given the apparent cheapness of the FloatingResets, it may be a good trade to swap the FixedReset for the FloatingReset in the market once both elements of each pair are trading. But that, of course, will depend on the prices at that time.

2 Responses to “AIM.PR.A & FFH.PR.E: Convert Or Hold?”

  1. adrian2 says:

    Thank you for the bolded conclusion!

  2. AltaRed says:

    Ditto… and for the analysis. Not that I own this one but I will likely need to make a similar decision in a few months on a different issue.

Leave a Reply

You must be logged in to post a comment.