In 2011 I wrote a short article on Seeking Alpha about preferred stock offered by closed end funds (CEF’s)—and I have loved CEF preferreds ever since that time.
What’s interesting about the article I mention above is that the 10 year treasury was trading at about the same level as today–but pricing on CEF preferreds were much stronger. The prime difference is rates were falling in 2011 and they are rising in 2022.
Today we are reaching a point where the current yields on many of the CEF preferreds are providing tantalizing dividend returns, in particular for those that are ‘immediate income’ (want a current income stream with less regard for share price erosion) investors and desire lots of safety.
I wanted to take a moment to review some of the CEF preferred issues and a few that are ‘term preferreds’ in particular.
At this moment there are 9 issues of CEF preferreds that are term preferreds–7 that are issued by CLO owner Priority Income Fund (not publicly traded) – these shares are unrated by the major ratings company’s. There is 1 issue outstanding from RiverNorth Specialty Finance with a 5.875% coupon (RMPL-) and 1 issue from XAI Octagon Floating Rate and Alternative Income Term Trust with a juicy coupon of 6.50% (XFLT-A)–neither of these issues are rated.
Disclosure–I own 2 issues of Priority Income Fund term preferreds and also the XFLT-A issue. I plan to purchase shares in RMPL- next week.
As you all know CEF’s are required to maintain asset coverage ratios of at least 200%–meaning they must hold securities that are worth at least twice the value of their ‘senior securities’ (preferreds and debt)–the higher the asset coverage ratio the safer the senior security.
An extreme example of asset coverage ratios would be the 5.00% perpetual preferred issue outstanding from CEF Tri-Continental (TY-P). This issue has been outstanding since 1963 and is a $50/share issue redeemable at $55/share anytime. The preferred issue is small, but there is an asset coverage ratio of 5300%—that spells safety. On the other hand like all perpetuals the share price can move sharply lower with rising interest rates–it traded as low as $18/share in 1981–but just the same the safety aspect was extremely strong.
Disclosure–I own a small TY-P position.
Next to Tri-Continental the Gabelli CEF’s have some of the strongest asset coverage ratios–from 260% to 952%. Unfortunately, for me, the Gabelli preferreds, have current yields a bit too low–in the 5.50% area and are all perpetuals meaning they may have more downside. Here again, if you are looking for super safety, some nibbles here might be appropriate with more purchases if prices fall more.
So back to the 2 term preferred issues I like the most right now–the term preferreds from 5.875% RiverNorth Specialty Finance (RMPL-) and XAI Octagon 6.50% (XFLT-A).
Both of these issues were holding well above $25 until just recently when their prices began to erode. RMPL- fell to $25.03 on Friday which makes it much more desirable than when the price was at $25.80 a month ago. The RiverNorth issue has a mandatory redemption on 10/31/2024–just 2.5 years away. While the CEF is not very well managed as an investor in the senior security I care mainly that they remain solvent and this will likely not be a problem (obviously no guarantees). The CEF has a current asset coverage ratio of 286% (as of 12/31/2021). At a current yield of 5.87% with essentially the same yield to maturity it is worth at least a 50% position for me. I will buy this next week assuming the share price remains around $25.03 or maybe a couple cents lower.
I like the 6.50% XAI Octagon Floating Rate and Alternative Income Term Trust (XFLT-A) and own a decent sized position right now (550 shares). It is my intention to buy more when I can get it at a slightly lower price than where it currently trades—$25.37. This is a current yield of 6.43%–BUT the yield to worst is under 5%, which makes this a little dicier–the 1st optional redemption date is 3/31/2023–less than a year away. My current assumption is the CEF will NOT call these early and they will run to maturity on 3/31/2026. Note that XFLT is a term trust and will be liquidated in 2029. I note that about 40% of assets are CLO equity–10% CLO debt and 41% of assets are senior secured 1st lien loans.
How will I buy these? I will put in good-til-cancelled orders. I am looking to buy the XFLT-A shares at around $25.20-$25.25. The RiverNorth shares I will try to buy right around $25–just below where they currently are trading. It should go without saying that if these issues fall below $25 the yield to maturity will rise and they will become very desirable buys.
As always this is not a recommendation for anyone to buy these issues–it is just what I am doing. Every single one of use has different needs and risk tolerances. Everyone should do all of their own due diligence if considering a purchase. You can access all SEC filings for all companies and issues mentioned here by going to the individual security links or from any spreadsheet which will take you to individual prospectuses or to the SEC page with all company filings.