Some Closed-End Fund Companies Refuse to Redeem ARS Preferred Holders

Over the past few weeks, some of the largest closed-end fund companies, including Eaton Vance Corp. and Nuveen Investments Inc., have disclosed plans to redeem their auction-rate preferred securities. This solution may allow some irritated investors to cash out quickly.   

However, many other closed-end fund companies have yet to announce plans to redeem their auction-rate preferred securities.  The reason given is to protect their common shareholders.  

Companies are worried cashing out preferreds right now will hurt their common shareholders. Therefore, the preferred holders may have to wait months or even years before they are able to cash in.   

Prominent closed-end operations that have not publicized a redemption plan include; Allianz SE’s Pimco and Nicholas-Applegate funds, Lehman Brothers Holdings Inc.’s Neuberger Berman funds, Bank of New York Mellon Corp.’s Dreyfus funds, and Pioneer Investments. Together they have totaled $7.6 billion of auction-rate preferred. 

Auction-rate preferreds are long-term securities that functioned like short-term investments. But, when the market stopped functioning like normal, buyers for these securities vanished in auctions. Holders have been stuck in a slump by fund companies since the credit crunch weakened in February.

Ed Dowling owns preferreds issued by five different companies, including $300,000 in Neuberger Berman, which is the only one yet to redeem any his securities. He is questioning the future of his funds and is even considering selling on the secondary market at a loss.   

The problem fund managers are struggling with is whether replacing the auction-rate debt with other leverage would be more expensive and would consume fund earnings. Action-rate financing has the benefit of longer maturities than bank loans and bonds typically have. Funds that replaced the preferreds with bank borrowings run a risk that the bank may charge a higher rate to extend the loan, or not extended it at all. 

According to the Wall Street Journal, when the market started declining there were about $64 billion of these securities issued by closed-end funds. Now, just 31 percent has been redeemed, or plan to be shortly.

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