2wr reminded me that I missed the obvious in this article.
All closed end funds have the right to call their preferred stock if they violate leverage rules–at any time. It is likely most funds would not want to do this because the income they receive from the fund is based on assets so they would be cutting their income.
“Cliff Hangers” are closed end funds (CEFs) that are nearing the minimum 200% asset coverage ratio (closed end funds must maintain 200% asset coverage on their senior securities). I took the term of “cliff hangers” from valued commenter “alpha” who used the term in comments on an article last week.
As some of you know there are numerous (actually probably 100’s) of closed end funds that are nearing, or even below, their 200% minimum coverage ratio and I see indications that ratings agency’s are watching these issues closely.
Of course I am not concerned with most of those closed end funds–I am just concerned with the company’s that have exchange traded preferred stock outstanding–some of which I own.
When markets are rocky like they are now there are always closed end funds that either near or breach the 200% coverage ratio. Back in 2008-2011 it was really common given the great financial crisis and I wrote an article on Seeking Alpha in 2011 detailing the actions the Gabelli funds took to ‘cure’ the issue they had at that time with some of their CEFs. That article is here.
So in general there are a number of ways a fund can cure their problem with their leverage ratio. They can sell more common shares, they can make a tender offer for some or all of their preferred shares (which requires they sell assets to pay for the tender offer) or they can even merge with another CEF that has a lower leverage ratio. I am guessing that the preferred method to cure the breach is to sell more common shares. Remember that the CEFs pay the manager of the fund–and the fewer assets the less the payment.
Interestingly we have some of ‘all the above’ going on right now–and honestly these actions are why CEF preferreds are safe (even though it doesn’t feel that way). Personally I probably have a higher risk tolerance for CEF preferreds nearing their 200% minimum coverage ratio’s only because I have followed the process so closely.
So let’s look at what is happening at some of these closed end funds.
1st off the Virtus AllianzGI Convertible and Income Fund (NCV) has a 5.625% perpetual preferred issue outstanding (NCV-A). Shares are now trading at $22.03 with a 6.38% current yield. The issue is rated “A” by Fitch–the shares had been at “AA”, but were downgraded in May, 2021. On May 18, 2022 Fitch reaffirmed the rating.
NCV uses 2 types of leverage for their fund—exchange traded perpetual preferreds of which there are 4 million shares are outstanding ($100 million) (NCV-A) as well as auction rate preferreds (ARPS)–about $219 million in ARPS outstanding as of 7/31/2022. Total assets were $712 million on that date. Of course they have lost asset value since 7/31/2022 so they are now likely in violation of the 200% minimum.
So what do they do? On 9/28/2022 the company announced a tender offer for all ARPS shares outstanding. Here is the formal SEC filing and supporting documents. If we were to assume 100% participation in the tender NCV would reduce their leverage by $219 million–leaving only the $100 million of NCV-A outstanding. So how will they pay the $219 million? They will have to sell securities as I see no offerings being made to sell more common shares. This is the ‘house of pain’ to the manager since total assets are going to fall dramatically and they will make less in fees.
If we assume further that assets have fallen 10% since 7/31/2022 to $641 million and they have to sell $219 million to pay for the tender offer they will further reduce assets to $412 million. Voila!!!! We now have a coverage ratio of about 400% on the NCV-A shares ($412 million divided by $100 million).
NOTE–I believe these numbers are correct–BUT do you own due diligence. Also there is history on ARPS–dating back to the great financial crisis–readers will need to Google it–but essentially they are not callable in this case which is why NCV is having to make a tender offer.
Additionally the NCV-A shares are callable early for leverage reasons–but they have not been tendered for at this time.
2nd is the Virtus AllianzGI Convertible and Income Fund II (NCZ). They have a 5.50% perpetual preferred outstanding (NCZ-A).
Exact same story as the one above–same company–same story. Here is their press release and here are all the details.
Now moving onto another issue–RiverNorth Opportunities Fund (RIV). The company sold a 6% perpetual preferred (RIV-A) on 4/12/22–3.91 million shares (3.4 million and 510,000 over allotment). Shares are now trading at $23.20 for a current yield of 6.47%. Shares are rate A1 from Moodys.
As of 7/31/2022 the company had a coverage ratio of 281%–but reader ‘alpha’ anecdotally believes it is closer to 210% now–if true they are near breaching the 200% level.
On 10/4/2022 the fund announced a rights offering which could potentially result in the issuance of about 6.2 million common shares – about $70 million in proceeds at todays prices. Here are the official SEC documents.
A successful rights offering will raise the coverage ratio substantially.
Moving on further to RiverNorth Specialty Finance Corp (RSF) which has a 5.875% Term Preferred outstanding (RMPL-) which is now trading at $24.51 and which has a mandatory redemption due in 10/31/2024. The preferred is not rated.
The company had a coverage ratio of 257% as of 6/30/2022–and it is fair to assume that the coverage is much lower–although probably not quite at the point of breaking 200%.
Likely in anticipation of lower prices yet on 10/13/2022 the company filed an initial registration statement to sell common shares, preferred shares and ‘rights’ for common and preferred shares. The registration statement is for $150 million–and I think it is a fair assumption that this is a potential common share and common rights offering—since that would resolve their potential leverage issue. NOTE that this is a small fund of $108 million in total assets as of 6/30/2022 so even a small common share offering (say $50 million) would up their coverage ratio substantially.
Lastly lets look at the Aberdeen Income Credit Fund (ACP) which sold a 5.25% perpetual preferred on 5/3/2021 (ACP-A) which is trading at $21.07 for a current yield of 6.23%. The preferred is rated A2 by Moody’s.
The fund has a coverage ratio around 230% as of 7/31/2022 and it is fair to assume a lower ratio now.
In what appears to be an initial move to bolster their asset coverage they are merging with another CEF. The CEF being acquired has a lower level of leverage and the merged companies would be much lower than ACP on it’s own. The 2 funds are relatively the same in size. Documents can be found here.
If markets continue to soften I believe the merged funds will take further action.
NOTE–this one is a bit of speculation on my part.
For now I am quitting – this is getting long and the pay is meager.
OTHERS CLIFF HANGERS
Gabelli Multimedia Fund GGT-E 200% coverage–Rated A 2
Gabelli Multimedia Fund GGT-G 200% coverage–Rated A 2
No Action Taken at this point by Gabelli.
XAI Octagon Floating Rate 6.50% Term Trust Term Preferred XFLT-A — Not Rated
The fund has an ‘at the money’ offering of up to 18 million shares in place so likely they are raising some funds. I expect they will take further action–including the redemption of XFLT-A in March,2023 when it is initially redeemable.
Disclosure–I own RIV-A, RMPL- and XFLT-A. This is not a recommendation to buy or sell anything. Each person needs to do their deep due diligence to understand these issues.
16 thoughts on “Revisiting Closed End Fund “Cliff Hangers” – UPDATED”
Although the pay may be meager, the time and attention it takes you to prepare your work is hugely appreciated…. I especially appreciate your efforts and investigation into the closed end fund preferreds, as I am invested in several…. I like to stay informed about the coverage ratios, and how they are handling any deficits, so thanks again.
Thanks for your nice compliment bethink–I appreciate it greatly.
Tim – ON XFLT_A you mention “I expect they will take further action–including the redemption of XFLT-A in March,2023 when it is initially redeemable.” That implies that you don’t believe they have the ability to call them to the extent necessary to meet the asset coverage ratio requirement if necessary…. That’s not right, is it? I think all these CEFs have the right to call prior for the first optional call date if they want to to the extent it’s necessary to meet the coverage ratio… Am I wrong?
2wr you are correct–they all have the ability to call to for leverage reasons. I am simply thinking they may limp through above 200% for a number of months then it would simply be a luck of timing they can redeem and it would solve any problems (assuming they have some). Certainly they can call prior if necessary–the good part is shares are below $25 now ($24.69) so the call risk is minimized. On long writings like this one I may write something that should be clarified—my old brain goes dead after a few hours of scouring SEC documents.
Thanks for this.
Do you watch GDV-K (Aa3) along with the other Gabelli ones you mention?
It needs to drop a lot more, but not sure about coverage.
Gary–I don’t watch them much because the yields are small–but I don’t worry about them because the Gabelli team knows how to deal with coverages.
GDV-K has more than enough coverage – one of the highest coverage ratios in the CEF universe. You can see it for yourself on CEFConnect.com:
As of 10/24/2022
Total Investment Exposure: $2,393.536M
Total Common Assets: $2,041.936M
Common Shares Outstanding: 90,271,286
As of 10/24/2022
Preferred Share Assets: $56.500M
Total Debt (USD): $295.100M
Regulatory Leverage (USD): $351.600M
Effective Leverage (USD): $351.600M
Effective Leverage (%): 14.69%
GDV has two oustanding fixed rate perpetual preferreds. 4.25% GDV+K (6 million shares) and 5.375% GDV+H (2 million shares).
GDV also has a $145M Series J preferred outstanding that is private and pays a rate of only 1.7% fixed until 3/26/24; and then at a fixed rate of 4.5% until Series J is mandatory redeemable on 3/26/28.
GDV is one of the best capitalized CEFs in the entire CEF universe.
Take a look at GAM-B, a perp preferred of GAM, a long running CEF. Not as safe as TY- but pretty damn safe. Has been selling below par the last few days but much safer than most, with a higher coupon than TY-. It rarely gets close to par, let alone below. Worth a look as a place to stash some cash while awaiting future opportunities. And please don’t buy too much – save some for me!
Any thoughts on HFRO-A? Had a big down move recently?
LVS–I don’t trust these folks–there is a story here which I don’t remember but will check deeper into it.
I believe HFRO is trying to convert into a holding company and therefore would not be restricted by a leverage ratio as a closed-end fund.
Thanks blkrahn–I know there is a story there–I though the changeover was shot down by shareholders.
Tim I recall about a year ago we were drilling into their holdings. It appeared at the time the assets were mostly illiquid oddities, and digging further it appeared they were linked to other companies they managed – so not arms-length.
Ratings notwithstanding, the coverage being only as good as the underlying, yeh, not touching this one.
alpha–if you are referring to Highland yes they had bunches of dogs and cats–scared me away. They still have some dogs and cats but at least they have delevered.
Aren’t the Priority Income Term Preferreds structured the same way?
Yes they are CEF’s subject to the 200% minimum–but they have been selling tons of the common shares so I think they are ok–but I haven’t look real close.