Duff & Phelps Investment Management Co. Provides Information on Preferred Share Auctions
Published February 19th, 2008
CHICAGO - Duff & Phelps Investment Management Co. today commented on the disruptions in the short-term fixed income market that have resulted in recent failures in the periodic auction or remarketing of certain series of preferred stock issued by many closed-end funds, including the three closed-end funds advised by Duff & Phelps: DNP Select Income Fund Inc. , DTF Tax-Free Income Inc. and Duff & Phelps Utility and Corporate Bond Trust Inc. .
Duff & Phelps believes that the auction and remarketing failures that have occurred with respect to the preferred shares of its closed-end funds are related to general quality and liquidity concerns in the credit markets, and not to any problems with the creditworthiness of the Duff & Phelps closed-end funds or their preferred shares.
The preferred shares of all three Duff & Phelps funds are currently rated Aaa by Moody’s and AAA by Standard & Poor’s, as they have been since they were first issued. In addition, the assets that support the preferred shares are primarily stocks and bonds of electric, gas, and communications companies and currently have no direct mortgage exposure. All three funds are in compliance with the asset coverage tests under the Investment Company Act of 1940, which requires each of the funds, as a condition of being able to pay dividends to its common shareholders, to maintain assets equal to at least 200% of the liquidation preference of its preferred stock.
An auction fails when there are insufficient clearing bids to purchase all the shares that current holders wish to sell in an auction, and a remarketing fails when the remarketing agent is unable to set a dividend rate that will clear the market of all the shares that current holders wish to sell in a remarketing.
A failed auction or remarketing is not an event of default of the issuer and does not impair the issuer’s ability to pay timely dividends to preferred shareholders or to repay the principal amount of the preferred shares when required to do so by the terms of the shares. A failed auction or remarketing means that the current holders retain their shares until the next periodic auction or remarketing, and the dividend rate for the next dividend period is automatically set to the maximum dividend rate permitted by each fund’s charter. It is possible that future auctions or remarketings will also fail, and therefore holders of preferred shares may not be able to obtain liquidity from the auction or remarketing process at all. Some broker-dealer auction or remarketing desks may try to facilitate secondary market trades apart from the auction or remarketing process. Such a secondary market, if it does materialize, may not provide preferred shareholders with the degree of liquidity or share value they desire.
One implication of the auction and remarketing failures for common shareholders of Duff & Phelps closed-end funds is that the cost of financing a fund’s leverage likely will be higher than it would have been if those costs were determined through a successful auction or remarketing process. This means that common share earnings likely will be marginally lower than the earnings the common shares would have otherwise earned. At the present time, the earnings on the funds’ assets continue to exceed the dividend rates on the preferred shares based on the funds’ maximum applicable rates and, therefore, the preferred stock leverage remains beneficial to the common shareholders of the funds. However, there is no assurance that this will continue to be the case in the future. If any of the funds were to determine that its current leverage structure was no longer beneficial to the common shareholders, it could modify or eliminate that leverage structure. It is possible that eliminating a fund’s leverage could negatively impact the income-generating capacity of the fund.
Duff & Phelps will continue to monitor conditions in the closed-end fund preferred stock market, in furtherance of its fiduciary duty to act in the best interests of the shareholders of the Duff & Phelps funds.
DNP Select Income Fund Inc. is a closed-end diversified investment management company. The Fund’s primary investment objectives are current income and long-term growth of income. The Fund seeks to achieve these objectives by investing primarily in a diversified portfolio of equity and fixed income securities of companies in the public utilities industry. For more information, visit the Fund’s website at http://www.dnpselectincome.com or call the Fund at (800) 864-0629.
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