Recent disruptions caused by an imbalance between buy and sell orders in the auction market for auction rate securities in the U.S. have led to questions about the impact to closed-end funds. Reaves Utility Income Fund (the “Fund”) issued outstanding Auction Market Preferred Shares (“AMPS”) in June 2004. The AMPS issued by the Fund are senior equity securities and have priority over the Fund’s common shares as to distribution of assets and dividends, as described in the Fund’s AMPS prospectus.
Under normal auction market conditions, dividends on the AMPS for each dividend period are set at a rate determined through an auction process that brings together bidders who seek to buy AMPS and holders of AMPS who seek to sell. Investors and potential investors typically purchase the AMPS in an auction by submitting orders to a broker-dealer. However, as stated in the Funds’ prospectus, an AMPS shareholder may not be able to find a buyer of the AMPS at an auction if there are not enough buyers. In such unusual market conditions, which the AMPS currently are experiencing, a shareholder may have difficulty finding a buyer.
These current market conditions are not anticipated to significantly impact the Fund itself. Shareholders in the Fund should keep the following in mind:
- Whether under normal auction market conditions or in the event that an auction does not occur, the dividend payment rate for the next period for the Fund’s AMPS holders is limited to the specified maximum applicable rate. In the case of a failed auction, the dividends will be accumulated at the applicable maximum rate until an auction can establish a market clearing rate. The specified maximum payable rate is the current applicable LIBOR rate (the “reference rate”) plus 125 basis points or 125% of LIBOR, whichever is greater. If the AMPS are rated lower than “AAA” by Standard and Poor's Ratings Group, a division of The McGraw-Hill Companies, Inc. (“S&P”), and “AAA” by Fitch Ratings, Inc., the 125 basis points and the 125% of LIBOR will increase to as much as 300 basis points and 300%).
- As of July 26, 2010, the maximum payable rates for the Fund’s 7-day and 28-day series were 1.558% and 1.75%, respectively. This interest rate is in line with the AMPS rates set prior to any auction failures. The Fund anticipates no disruption to dividend payments to all AMPS holders.
- The assets of closed-end funds, which are valued on a daily basis, serve as the collateral for issuance of the AMPS. The AMPS must meet certain specified asset coverage tests, which include a requirement set forth under the Investment Company Act of 1940 that closed-end funds maintain asset coverage of at least 200% with respect to the AMPS and any other outstanding senior securities; i.e. closed-end funds must have at least $2 of collateral for every $1 of AMPS issued. The Fund remains in compliance with all AMPS asset coverage tests.
- S&P* and Fitch** have each assigned the Fund’s AMPS a “AAA” rating. These ratings are not supported by any credit enhancements by insurance companies.
- The favorable spread between borrowing costs and investment returns continues to exceed the costs of the AMPS, based on the maximum applicable rate.
* preferred stock rated AAA by Standards & Poors have the highest rating assigned by Standards & Poors. Capacity to pay interest and repay principal is extremely strong.
** preferred stocks rated AAA by Fitch are considered to be investment grade and of the highest credit quality. The obligor has an exceptionally strong ability to pay interest and repay principal, which is unlikely to be affected by reasonably foreseeable events.
The Fund continues to closely monitor developments in the AMPS market during this market disruption. Click here to obtain a copy of the Fund’s AMPS prospectus or call 800-644-5571.
