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Strategies & Market Trends : Bonds & Bond Funds
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From: peter michaelson12/17/2008 8:38:53 PM
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Another copied post, this one regarding a new form of leverage that may avoid the dividend suspension risk.

socialize.morningstar.com
It is an interesting question as funds are scrambling to refinance their ARPs. The auction v. non-auction feature of the security should not change the asset coverage calculation, rather it is whether the security is debt (300% minimum coverage) preferred (200%) or exotic (special coverage provision).

It looks like what certain funds are doing, in setting up tender option bond refinancing, is taking advantage of SEC guidance which states that the commision will not hold CEFs to the asset coverage provision of the 1940 Act if the security in question is 'covered' by segregated assets. So, the fund transfers assets to another entity, which issues TOBs to investors and passes through the cash received to the CEF. The fund then uses this cash received to pay down its ARPs or other indebtedness, and thus frees up breathing room under the 200/300% windows to resume distributions.

It seems like a desperate move, but a pretty smart one at the same time. The financing cost is probably higher for a TOB given what I can figure out about these securities, so it is stricly a putting fires out kind of transaction.

So it is really not a safer form of leverage, just another derivative that comes with all of the same question marks as any other exotic (for instance, under what terms can the investor put-back the TOB to the fund?)
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