Aspen Insurance Holdings Preferred Stock: A Rare Opportunity (NYSE:AHL.PC)

Introduction

For much of the last 10 years, interest rates were sitting at 60-year lows. With the Federal Reserve firmly engaged in taming the inflation dragon, interest rates are rising quickly. The Federal Reserve has all but committed to yet another 75-basis point bump in rates at the November meeting of the FOMC. This combination of coming from a period of historically low rates to a period of accelerated increases in rates is setting up a unique investment opportunity for a particular class of fixed income securities.

There are some great opportunities in securities with fixed-to-floating conversions in the next couple of years, in particular, those securities that had their IPO during the period of historically low interest rates. Aspen Insurance Holdings Limited preferred shares (NYSE:AHL.PC) is one of those opportunities.

Investment Thesis

Aspen Insurance Holdings Limited (formerly traded under symbol AHL) initially offered AHL.PC in a prospectus dated April 1, 2013. The AHL.PC preferred shares are non-cumulative, perpetual, fixed-to-floating securities with an initial coupon rate of 5.95% ($1.4875). The conversion to a quarterly floating rate is after 7/1/23 at a rate of 3-month LIBOR plus 4.06% and the shares are currently priced at $22.32 with a $25 par value. In early 2019, AHL was acquired by Apollo Global Management (APO). AHL is now wholly owned by APO.

At the time of the IPO, AHL.PC carried a credit rating of Ba1 by Moody’s and BBB- by S&P. Today, the corporate credit rating of APO is A by Fitch and A- by S&P. AM Best and S&P rate AHL as A (excellent) and A- (strong) respectfully. Typically, preferred stock carries a credit rating two to three notches below the corporate rating, which would put AHL.PC at BBB or BBB- (S&P scale). I could not find a current credit rating published for AHL.PC. However, with the APO and AHL corporate credit ratings at A-, I’m not going to lose any sleep over holding of AHL.PC.

I’m expecting the full 75-basis point increase in overnight rates after the November FOMC meeting and another 25-50-basis point increase in December. That would put the Federal Reserve overnight funds rate at 4-4.25% and should put the 3-month LIBOR rate at 5.25 to 5.5%. We could also see additional, but probably smaller increases in early 2023. To be a bit conservative in this investment thesis, I’ll use the 5.25% estimate for the 3-month LIBOR rate.

The current and potential future returns from AHL.PC are as follows.

• Current yield based on a price of $22.32 is 6.66%
• Floating rate based on 3-month LIBOR of 5.25% would be 9.31%
• Coupon rate after converting to the 9.31% floating rate would be $2.33
• Yield on cost based on the $22.32 price would be 10.4%
• Yield to call based on the $22.32 price would be 25%

With a new floating rate over 9%, I expect AHL will choose to call in AHL.PC on or shortly after the 7/1/23 first call date. With an inverted Treasury yield curve, it will be cheaper for AHL to refinance at a long-term interest rate. If called 7/1/23, the investment in AHL.PC will provide investors with three dividend payments of $0.372 plus the $2.68 difference between the current price and par value, a 17% total return over approximately 8 months. That 17% total return translates to an annualized YTC of 25%.

This opportunity looks to be a win whether AHL calls the preferred shares on or shortly after the 7/1/23 call date, or whether AHL decides to pay the dividend at the new and much higher floating rate. Investors will either get a YTC of 25% or dividend payments of ~$2.33 initially and floating quarterly thereafter. There are other fixed-to-floating rate securities offering higher potential total returns and higher YTC (e.g. RITM.PB and AGNCM) but those higher yielding securities also carry higher credit risk. Potential AHL.PC investors should consider that AHL.PC provides high double-digit returns from a company with a solid investment grade credit rating. This is a sleep-well-at-night investment.

The AHL.PC IPO was for 11M preferred shares and the typical daily trading volume is 10,000 to 14,000 shares, so liquidity is decent. I’ve accumulated a small position and plan to accumulate more after the November FOMC meeting, as I’m expecting the typical volatility to ensure after the FOMC announcement.

Conclusion

The Federal Reserve inflation fighting efforts have taken a toll on equities the last few months, and the expectation in financial circles is that the risk of a recession in 2023 is growing. I believe common stocks will continue to be volatile, and the current bull breakout is unlikely to last, with more rate hikes in the offing and the risk of a near-term recession growing. I’m not going to try to fight the Federal Reserve, rather, I’m going with the obvious opportunities that the Federal Reserve is creating.

Fixed income opportunities in fixed-to-float securities like those available today are rare. I plan to take full advantage of them.