Further on Highland Income Fund

We did some really quick and dirty due diligence on the Highland Income Fund (NYSE:HFRO) and unfortunately most of the CEFs holdings are Level 2 assets. This means some there is some observable data from which to value the assets (versus Level 1 which is for instance common stock).

We love the funds with level 1 assets (mostly Gabelli related funds)–but we can live with Level 2 given that they will need to maintain a high asset coverage ratio. As of 12/31/2018 their asset coverage ratio was 306%. With this type of investment we watch the coverage ratio more than the fund performance–this is the important part of making our capital secure.

The fund has net asset of just over $1 billion (as of 12/31/2018) and has been in existence since 2000.

We are less excited about this issue than we were 10 minutes ago when irrational exuberance got the best of us.

At a reasonable price on the OTC Grey market we will likely still purchase a small position in this new issue.

53 thoughts on “Further on Highland Income Fund”

  1. Interesting – I had a buy order today with Schwab for 500 shares at a limit of 24.76. From what I can see there were trades logged at 24.75 today. Have a call into Schwab to see why it did not execute.

    1. Proto – this is not an unusual scenario on the gray market. I have had that happen several times and I am also with Schwab. The first time it happened I call them to inquire and was basically told that the gray market is “the wild wild West” with less orderly/efficient trading versus when trading on a big board.

      I maintain patience and hope that my order fills. Most of the time it does but sometimes it doesn’t and I have to either raise my limit price or move on to the next issue.

    2. I’ve had trouble getting All-Or-None (AON) trades executed with Schwab, its like the order drops into a black hole. When questioned Schwab says they pass “special orders” off to another market market maker so the order does not show up ion they SMART order system.

      1. Mikeo – Black hole is a great description… It’s not just at Schwab, my experience at TDA and Fidelity has been if you’re interested in seeing shares of anything trade higher than your order, lower than your order or at your order price without your shares executing, use the AON qualification… It’s the best way out there for your order to be ignored..

        1. To clarify my post, I never use AON…. which resulted in me getting all of 2 shares of NYCB-U the other day. I hate it when that happens but I still never use AON. Thank you for pointing out that it can be a problem to do so.

  2. Just as a reminder for anyone wanting to grind something out very modestly and yet not be exposed perpetually. Allowing for half divi accrual at present $50.68 price, GDL-C will squeeze you out a 3.65% QDI YTR. With assumption of buyer putting them back to Gabelli in March 2022 per terms of prospectus.

    1. Good reminder Grid–I have a taste already. This is one of the few Gabelli CEF preferreds that is unrated. There are 2 period when shares can be ‘put’ back to GDL for $50. The 1st is in 2020 (essentially the full month of March) and again in 2022 (the month of March). There is a mandatory redemption in 2025. The preferred came to market at 4% coupon which is where it now remains until 2021–then resets somewhere between 4% and 6%.


      1. Tim, I think based on what I think is correct it puts in 2020 and 2022. I should have mentioned 2020, but didnt see a lot of meat on the bone that soon. I loaded up on that at par and flipped around $52 when it shot right out the gate. I dont own it now, but maybe I should.
        The Fund will redeem all or any part of the Series C Preferred Shares that holders have properly submitted for redemption and not withdrawn during the 30-day period prior to each of March 26, 2020 and March 26, 2022, at the Liquidation Preference, plus any accumulated and unpaid dividends. See “Puts and Redemptions.”

        1. Grid–mine is buried deep in the sock drawer–most days don’t look at the price even. Only 100 shares.

          1. Tim and Grid, Originally started sitting on some GDL-C just to get $$ out of the 2% penalty box during the falling rate cycle. Now thinking if trends continue we may come to value the position a bit more as the months roll by to 2022. Imagine deciding to hold in 2022? It could happen.

          1. Funny you posted that, Tim…I was thinking..”What was the name of that other one”…But couldnt remember the name. This was the one.

        2. Has anyone actually gone through the put process on any of these?

          I presume it’s not necessary, as they should trade at/above par immediately prior to the put deadlines.

          1. Also, I’m not sure you can count on the distributions from this merger arb fund being QDI:

            The Fund expects that distributions on the preferred shares may consist of (i) long term capital gain (gain from the sale of a capital asset held longer than 12 months), (ii) qualified dividend income (dividend income from certain domestic and foreign corporations) and (iii) investment company taxable income (other than qualified dividend income), including interest income, short term capital gain, and income from certain hedging and interest rate transactions. The Fund expects that a substantial portion of its income will consist of short term capital gains. For a more detailed discussion, see “Taxation.”

          2. 730Cap – Put process is pretty easy, but what’s important to keep in mind is how dramatically the security changes if you let the second or last put go by without acting…. Then, what’s been acting like a 2 year piece of paper becomes a perpetual, so you have to keep that in mind when making that last decision… I’m long GDL-C, GGO-A and GLU-B. What happens when the final put expires can be seen in the chart of GLU-A. The impact was somewhat mitigated by Gabelli offering a swap into the GlU/GLU-B package but still today, there’s a tiny amount of GLU-A still outstanding from those who ignored doing anything…. GLU has said they might call GLU-A but it makes no economic sense, just housekeeping sense from their point of view, so GLU-A is probably trading higher than it should… Then again, it’s a preferred trading at a discount to par…. Who’s ever heard of that even being possible in this day and age??

            1. W2R, I have…My last purchase of IPWLO was at $83, 17% below par. Maybe that 4.2% perpetual yield from 1940s has something to do with it? 🙂

              1. I knew I should have qualified what I said and said, “who else other than Grid’s ever heard of a preferred trading at a discount nowadays…..” lol

            2. 2wr—you got it right on the nut with these 4 issues–I was going through them last night as I hold a couple and don’t pay any real attention to them–don’t want to miss that last put date.

            3. How does the put work? Is it like a tender offer where they send a form through your broker and you can make the election through the broker website?

              1. 730, I suspect you are correct. But your first thought is correct in what I have seen. You will almost certainly be able to just sell them into market, as there wont be a freebee given. If I remember I had to fill out a form to get the GBL-C. That was the reason why I bought the GBL-B was to buy up an over allotment of the C. Gabelli also is pretty good about posting that stuff on their specific website, based on what I had followed anyways.

              2. 730 – It’s not really handled like a tender unless you’re talking about the final put option…. Then there’s teh possibility of a tender if there’s an exchange offer given… Other than that it’s black and white… you elect to put them back at par or you elect to keep them based on the terms established at the time of the put… I think all Gabelli put situations have floors so you know the worst case possibility and the likelihood of that being the new rate, then you just decide if that’s good enough for you or if you think the preferred will trade at a price better than par after the put date..

                1. I’m really asking about the mechanics of how to exercise the put. Do they proactively send you a form? Can you exercise it on-line? Certified mail, notarized, etc? They don’t really want you to exercise the put, so I’m not sure they make it easy lol

                  And for these tiny oddball issues, not sure if I would want to completely rely on a market bid, especially if markets are turbulent. But I guess one of Arbitrage Trader’s minions will be on it.

                  1. 730, history showed me quality illiquids bought at correct price in times of turmoil hold up better than market liquid driven issues. That is how I avoided losing money selling into December rout, and then made money off it. I sold off my illiquids that had strong standing bid orders and then bought into the market rout. Of course you dont want to try an instant dump $300,000 worth of AILLL, for example, and expect it not to collapse though, lol… The high quality illiquids of the 08-09 crisis held up infinitely better than the liquid brothers that lost 60%-80% during that time.

                  2. 730 – Gabelli historically makes it very easy…. They’ve been very good at notifying well in advance with sufficient time to make a decision….. Then online’s a breeze. Of course, if you’re a belts and suspenders kind of guy as I tend to be you can always give yourself a reminder on your calendar to remind you when they’re coming… I’ve seen no evidence of Gabelli trying to make it difficult due to any bias against holders putting them back….. Another 2 issues of possible put exercise are the two TVA baby bonds, TVC and TVE… Somewhat complex to explain when they become puttable but they are another example of issues that weren’t made difficult to put in the past in any way.

                    1. Okay thanks. Although I still don’t really understand how it works, sounds like putting the Gabellis shouldn’t be too much of a PITA.

                      These seem marginally interesting at best, and losing even 50 bps selling in the open market in advance of the put would make them even less interesting.

      2. Hi!

        I see that GDL-C is callable in March, 2021. Has anyone calculated a yield-to-call?


              1. David, GDL-C is “Puttable” during March of both 2020 and 2022. Meaning one may submit the issue for redemption at par plus unpaid dividends back to the issuer, or just sell into the open market. As 2WR pointed out earlier, be careful to observe these dates with caution as what’s basically a 2-year issue becomes a perpetual after the latter date.

                Currently at $50.75, if distributions are re-invested, your YTC at the 2024 window is 3.61% with an equivalent QDI YTC of 4.51% (at 20% rate) and 4.24% (at 15% rate).

                See “Holder Put Options” at the top of S-8 in the attached. https://www.sec.gov/Archives/edgar/data/1378701/000119312518045720/d424047d497.htm#supptx424047_3

                Not a stellar rate, but darn safe and with the bennie of a 4% floor.

                1. I seem not to understand quite a bit of what people are writing here. I think several people have warned of it’s becoming perpetual after 2022.

                  P. S-19:

                  “The Fund is required to redeem the Series C Preferred Shares on March 26, 2025 at the Liquidation Preference, plus any accumulated and unpaid dividends. ”

                  Could anyone clarify, please?

  3. Fascinating history about HFRO (a cef) which was originally HFRAX (a OEF). HFRAX was a big investor in a Las Vegas development and lost big-time when the project went bankrupt. HFRAX assigned their claim to Claymore Holdings who sued Credit Suisse (in Tx. state court). Credit Suisse had been hired by the developers to arrange financing. Gist of the lawsuit was fraudulent appraisal obtained by Credit Suisse. In 2015 Claymore wins 287 million judgment and post judgment interest at 9%.
    HFRAX is the big beneficiary of this judgment and then converts itself into a cef (HFRO). Judgment was affirmed by the Tx Court of Appeals and is not pending before the Tx Supreme Court!

        1. Great–I grew up a ‘husker’ fan in Council Bluffs IA—I knew nothing about Cyclones or Hawkeyes.

          1. Tim, I would be inclined you would be a GG fan and would answer Husker with GGG. Its good to know there is good B10 representation here.
            Best regards, a “Tyler Strong”

            1. ok–you must be a boilermaker–my connection to Purdue is my Grandfather went there and pitched for them – must have been around maybe 1910–nope 1914 – just looked it up in the “Purdue Exponent”.

  4. Maybe it’s me. I just can’t get excited about a security with a 5.38% coupon with no maturity date. If/when interest rates start to rise, I hope you all can pull the trigger to get out quickly enough. I think I’d rather be in the 2% money-market funds and waiting for better opportunities than this one. To each his own…..

    1. Gumfighter…..you are reading my mind…..I really hesitated buying this one but was bored and had an itchy trigger finger.

    2. Gumfighter—this is one of those you buy for the income stream and try to ignore the share price. I have quite a few similar issues (Gabelli related issues). When I was younger I watched share price–now I try to ignore it and make plans based upon my income stream.

      1. I got it at 24.84 (5.41% YOC). This compares well with GAB-J 5.45% which I bought at par. I also have CEF pfd’s from Allianz – NCV-A (5.625% coupon, 5.84% YOC) and NCZ-A (5.50% coupon, 5.77% YOC).

        Safe income and safe principal.

      2. Moody’s A1 rating kept surfacing in my mind. Some have posted here that those assigning ratings know better …. one of those was Grid’s. I compared to the Gabelli CEFs’ ratings and found only one to be higher. So I probed – bought at 24.81 and 24.80.
        A 5.375 coupon may currently seem low but perhaps not so if current trend persists.
        For my personal situation, these lower yielders with high IG serve a better alternative to the current CD rates. I know little (and hence bought but a little)
        Best regards, No 12

  5. Yes, I remember that article and all the others you wrote.

    The SEC filing for HFROP says that if their asset coverage gets in trouble, they must take action (including partial redemption of the pfd’s) until 220% coverage is reached.

    AFAIK, TYG-PB did a full redemption, all at one time. I wrote to their IR asking for info and they never replied.

    1. Hi Larry–I haven’t had time to go through the prospectus closely but will be doing so. Normally there are multiple ways to ‘skin the leverage cat’.

  6. Tim, my understanding of CEF preferreds is that if they get anywhere close to violating their asset coverage requirement, they will redeem the preferreds at par. The SEC filing discusses this.

    The only such redemption I know of was with TYG-PB a few years back. Their asset coverage got sorta close to the requirement. Do you know of any others?

    Asset coverage is somewhat fun to watch, but I never thought of it as “the important part of making our capital secure”. I mean, I think I know what you’re saying… but the capital IS secure, no matter what the asset coverage does.

      1. Seems to me that the problem w/ HFRO and other Highland or NextPoint cefs is that they are somewhat a black box or as others have said, hedge funds in a cef wrapper. Have a look at their portfolio. No real markets for some of these. Real/actual NAV is a likely a wild guess. So coverage ratio is a really big issue with these pups.

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