Calling a convertible: convert, sell or redeem?
A private client holds £5,000,000 nominal of a 4.50% convertible bond issued by Halden Group. The bond is convertible into ordinary shares at £8.00 per share and is repayable at par on 30 September 2029. The issuer has now called the bond for redemption at par plus accrued interest on 15 November 2024. The last coupon was paid on 30 June 2024 and interest accrues on a 365-day basis. The current share price is £9.60 and the bond's clean price is 124.00. The client's marginal tax rate on income is 45%, while capital gains are taxed at 20%; he has unused capital losses. The shares are in a FTSE 250 company with average daily volume of 1.2m shares. The client says: 'I only want the safest income; I do not want equity risk. Just redeem.' The adviser notes the conversion value is above the redemption proceeds.
1. Calculate the redemption proceeds, conversion value and market sale proceeds, and rank them before tax.
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Accrued interest from 30 June to 15 November is 138 days: £5,000,000 × 4.50% × 138/365 = £85,068. Redemption proceeds = £5,000,000 + £85,068 = £5,085,068, i.e. 101.70 per £100 nominal. Conversion value: £5,000,000 / £8.00 = 625,000 shares; at £9.60 = £6,000,000. Market sale: clean price 124.00 plus accrued 1.701 = dirty price 125.701 per £100; £5,000,000 × 125.701% = £6,285,050. Ranking before tax and costs: sale £6.285m > conversion £6.000m > redemption £5.085m. The redemption is the worst financial outcome by about £1.2m compared with sale. The client's wish to 'just redeem' therefore destroys value unless the bond cannot be sold or the market price is not executable. The calculation should use the actual settlement date and the bond's day-count convention; if the bond uses 30/360, the accrued figure will differ slightly.
2. What should the adviser recommend, and what risks and client-instruction issues arise?
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The adviser should not simply process redemption. The client should be shown the three exit routes and the fact that sale in the market currently produces the highest cash amount. If the client wants no equity risk, selling the bond is more consistent with that objective than converting, because conversion leaves him holding 625,000 volatile shares. Conversion is only better than redemption if he wants the equity exposure, or if the shares can be sold at or above £9.60 after dealing costs; 625,000 shares is about half a day's average volume, so a block sale could move the price. The adviser should obtain a firm two-way price for the bond, check settlement and tax: a sale may realise a capital gain or loss, while conversion may defer tax until the shares are sold. The client's 'safest income' statement suggests he may not understand that the convertible already carries equity risk. The recommendation should be documented, and if he insists on redemption, the firm should record the instruction and explain the cost. If the firm is dealing on an execution-only basis, it must not give a personal recommendation but can still explain order types.
3. If the client insists on redemption, can the firm execute?
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Yes, a client can give a valid instruction, but the firm should first establish whether it is advising or executing. In an advisory relationship, the adviser should explain that redemption at par plus accrued is the lowest-value route and document the discussion. If the client still insists, the firm may execute the redemption in accordance with the terms, provided it is not misleading him or acting against his best interests without justification. The firm should check the notice period and whether the call can be exercised by the holder or only by the issuer; on a forced call the holder normally chooses conversion or redemption. If the bond is held in a discretionary mandate, the manager may need to act in the client's best interests and cannot simply follow an unsuitable instruction without review. A complaint should be handled if the client later says he was not told. The key is a clear record of the options, prices, tax and the client's decision.