U.S. closed-end funds still hold $26.4bn in auction-rate preferred shares - nearly 2 years after that market froze.  And, while that's a 57% drop from January 2008 - when $62bn was held by 347 funds - the large figure still surprised researchers at Fitch.  In all, about 61% of C-E funds, or 250, are still leveraged. 

For years, some C-E funds issued preferred shares as a way to leverage, boosting income for common shareholders. Many financial advisers represented the shares as liquid investments, but when the auction-rate securities market froze in February 2008, preferred shareholders suddenly were unable to sell.  Since then, some C-E fund managers have redeemed shares at par value, by reducing funds' leverage or through refinancing, and others have offered to buy the shares at below par value. 

The funds are required to maintain asset coverage of at least 200% with respect to senior securities - e.g., preferred stocks, and at least 300% with respect to debt securities.  That means, for each $1 of preferred stock issued, a fund must have at least $2 in assets.  Refinancings resumed in the second half of 2009 and first half of 2010 as asset values recovered, Fitch Ratings said. 

    Seeking Higher Returns.  Funds that have maintained the leverage seek to capitalize on its low cost and permanent nature, Fitch said while noting:  "Despite the fact that ARPS are currently paying a stepped-up dividend rate to compensate investors for failed auctions, the financing cost" may be "attractive compared to other leverage options."   [WSJournal, 9/1]