(The following statement was released by the rating agency)
Oct 9 - Fitch Ratings notes that taxable closed-end funds (CEFs) have taken significant advantage of extremely cheap short-term funding that has, in effect, increased yield to retail stock investors. However, the shift to shorter term funding can also expose them to increased interest rate and funding rollover risk.
We expect that Fed policies aimed at keeping interest rates low, such as the third round of quantitative easing and ample competition among banks to provide funding to CEFs, will keep short-term borrowing costs cheap and bank financing attractive. Still, we feel such short-term funding can pose higher risk, as lenders have the option to pull back or eliminate funding over a short period. During stressful market environments, CEFs might then be forced to seek more expensive funding or liquidate assets. Both options could prove very costly.
As a function of decreasing borrowing costs for term securities and desire to diversify funding base, a larger number of CEF managers are leaning toward terming out a portion of their debt. Market feedback suggests funds are seeking to move 50%-75% of their capital structure to three- to seven-year terms while retaining the remainder in existing short-term bank leverage for flexibility, cash management, and yield-curve diversification.
Going forward, we believe that leveraged CEFs will need to be more proactive in managing both sides of the balance sheet. Access to multiple sources of funding while balancing rollover risk with the cost of leverage under various interest rate scenarios is key.
For additional information on this topic, please see our report, "Taxable Closed-End Funds Reliant on Short-Term Debt Reap Low-Cost Funding at the Expense of Rollover Risk," available at
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. All opinions expressed are those of Fitch Ratings. (New York Ratings Team)