I share your concern about these APS refundings.  All the asset managers proclaim that the new financing will reduce costs of leverage OVER THE LONG RUN compared to penalty rates.  Although I've inquired by email of several managers, I'v gottenm no added info regarding the terms of the new (usually) bank financing.  I'm considering sending a note to our friends at the SEC who will stand these guys up straight fast.

Dick

One way that the CEFs might be able to reduce leverage costs is via the lack of SEC filings needed to issue and/or redeem bank borrowings and revolving lines of credit.

The APS require a lot more "paperwork" with extensive filings and legal work in issuing the Prospectus, shareholder communication via press releases, and now a long process of more filings to redeem the preferred leverage.

The bank financing will require none of the above. The fund will simply enter into an agreement with a financial institution to provide the leverage. To redeem or partially redeem the amount of the leverage the fund simply needs to pay it down. No SEC filings, no shareholder voting, no publicity required.

After the initial financing is set and the APS scandal fades into history (unless there are law suits as mentioned by David) shareholders will be able to read about the bank debt twice a year in the Annual and Semi-annual reports.

With no APS the funds also might not need to hedge with interest rate swap agreements which are costly for the common shareholder. That could possibly be another cost reducer.

Of course, we'd all like to see the actual terms of financing so that we can better judge if the leverage costs will "really" be lower, or if we are just being sold a feel good story.

Best,

Steve
 

 

Steve, I agree with much of what you say, however,

1. I'm reluctant to wait 6 months to find out whether my new cost of leverage is roughly the Fed Funds rate (or repo rate) or $LIBOR +400....or if the fund is actually "upside down" on leverage costs - carrying (say) preferreds with leverage more expensive than the avg "coupon" to preserve higher assets-under-mgt and related fees.  It's not clear to me why banks shoring up capital would squander scarce capital resources providing leverage to CEFs at rates lower than the current "penalty" computations in the high-2's to high-3's.

2. I HOPE savvy managers will continue to hedge leverage with swaps, particularly if they can lock in currently low rates for extended periods.

Regards,

Dick

A few of my funds claim that by going the bank loan route they are doing great things for us common stock owners. If true why did they not take these steps before being pushed into redeeming the preferreds?  Problems with carrying debt on the balance sheets rather than preferred stock?  Claims sound like we are going from the perfect setup  (ARPS) to ta more perfect setup!

Thank you all for your comments on this. Basically, my concern is if I should hold on to this CEF or not due to the current circumstances.

Since no one really knows yet whether the net result will be better or worse, it doesn't seem a particularly good basis for a sell decision.  The marginal uncertainty induced is probably less than already present in these funds from more fundamental  issues.  At least the sponsor, like many others,  is trying to remedy an unsatisfactory situation wrt ARPS.  I own HPI and will wait for a stronger signal

There are ancillary costs beyond the interest rate, yet unknown,  to all these leverage options.  The APS auction  fee, for example, is the second largest cost after management fees in the expense ratio.  Several time in size any of the other expenses.  This could be a significant offset to those of APS  alternatives. 

peterm,

I take a less sanguine view on the APS situation. The cost to redeem APS and then to replace with new credit is fraught with the risk of higher cost given the current tightening in credit. Since there are alternative forms of investment, you may want to consider  individual preferreds, CEF's that are not levered, or even MLP's rather than to take on the unique risk of CEF's with APS.

 David

FYI: I hold positions in 7 un-levered CEF's,  but I still have 2 muni APS CEF's that I have severely cut since the auction failures.

Thanks Arb-Alot, would you have any recommendations on a CEF with minimal or no leverage that has a decent yield? I am not ready at this time to sell but when the time comes, and it may be in a few months, then I will be looking for a replacement.

 

Since leverage rates, whether APS, bank loans or TOBS, are usually tied to US$ LIBOR, the continuing issue of bank under-reporting LIBOR could have a larger impact than that of APS alternatives.  The allegation is that in recent months,  the BBA correspondent banks have understated true rates by 7-10 bp, or more.  Ftrom Bloomberg

Libor Poised for Shake-Up as Credibility Is Doubted (Update2)

By Ben Livesey and Gavin Finch

May 13 (Bloomberg) -- The benchmark interest rate for $62 trillion of credit derivatives and mortgages for 6 million U.S. homeowners faces its biggest shakeup in a decade as lawmakers question if banks are understating borrowing costs.

For the first time since 1998, the British Bankers' Association is considering changing the way it sets the London interbank offered rate, according to Chief Executive Officer Angela Knight, who appeared before a parliamentary committee in London today. ``We've put Libor under review,'' Knight said in an interview yesterday. While she declined to discuss specifics, the BBA will announce changes May 30, she said.

The BBA, an unregulated London-based trade group, sets Libor by polling 16 banks each day on the rates they pay for loans in dollars, British pounds, euros and eight other currencies. The association is under pressure to show the rates are reliable following complaints by investors that financial institutions weren't telling the truth after the collapse of subprime mortgages nine months ago contaminated credit markets and drove up borrowing costs.

 

I'm glad to hear that the British are taking on the task of improving LIBOR reporting which may alleviate some cost of leverage.

Nevertheless, the cost of settlement of APS holders'  claims appears likely to be a cloud over levered CEF's for some time to come. You may have seen today's article on the second page of the Investing & Money section of the WSJ today.The article speculated that the impact on Wall Street banks from the APS problem may be more troublesome than mortgage-backed securities issue. The notion seems to be that liability for the mortgage-backed  securities was a systemic issue. On the other hand, the Wall Street banks were promoting the APS market and then just pulled the plug.

David 

Good points, but it's important to keep both the liability and the scope of losses straight.  While various broker dealers (marketers) will no doubt pay up some dough for having misrepresented LIQUIDITY of APS/ARS, the fact is that little or no value will be lost actually be lost.  CEF managers appear to have NO/very limited liability. These securities have not defaulted or failed.  Some folks inconvenience/opportunity costs have no doubt been high...but it was/is a liquidity issue, not a credit issue. So the comparison to MBS losses in the WSJ (which I didn't see, unfortunately), sounds like it has a pretty high BS coefficient --- comparing some APS/ARS "nuisance" suits and roughly zero losses to combined Mortgage/MBS losses anticipated to top half a trillion globally and hundreds of billions for the major banks/invesment banks and brokers.

Dick