PTY - PIMCO CEF Update: ARPS Go On The Chopping Block

2023-09-01 04:32:44 ET

Summary

• We provide a July update for the PIMCO CEF taxable suite.
• Taxable coverage fell for the second straight month while tax-exempt coverage remained stable.
• PIMCO is doing a tender offer of their very expensive auction-rate preferreds.
• PIMCO taxable CEF valuations remain expensive in both absolute terms and relative to the broader CEF market.

In this article, we provide an update on the PIMCO CEF suite. Specifically, we discuss the changes in leverage and distribution coverage for the month of July. We also highlight the upcoming tender offer of the Auction Rate Preferred Securities or ARPS.

Coverage Update

Coverage across both taxable and tax-exempt funds was fairly stable.

The previous coverage jump in the taxable suite has not lasted and average coverage has fallen slightly for the second straight month.

Biggest drops in coverage were in PFL, PHK and PGP while PDI, PDO and RCS managed a modest rise.

The usual suspects of rising leverage costs as well as deleveraging are taking a toll on net income.

Leverage Update

Total borrowings in the taxable suite fell back after a jump in June. Recall that the June rise was due to a sudden jump in PDI borrowings - by far the largest fund in the suite - even as most funds cut borrowings.

July saw a partial reversal in PDI borrowings and a cut in nearly all other funds.

The average level of leverage in the taxable suite has kept falling and stands a bit north of 30%. This is well below the 40%+ levels we saw a year ago.

The variability in leverage levels in the suite is striking, ranging from PHK at just 17% to PCM at above 47%.

Market Themes

PIMCO recently issued a press release about a tender offer of their ARPS. For PIMCO the reasons are clear. Corporate credit spreads are pretty tight and ARPS interest expense is sky-high (see chart below) so it makes sense to both get rid of the ARPS and to deleverage a bit - two birds with one stone.

This isn't the first time it's happening - PIMCO has held ARPS tender offers before and did get some interest but not all that much at the price they were willing to pay.

We don't know yet if the funds are deleveraging or just replacing the ARPS with cheaper leverage. It's a little surprising that the funds took so long to try to get rid of the ARPS. The taxable funds are paying rates of 8.5-10.7% on these whereas repo costs around 6% or so. In effect the funds have been overpaying for their leverage for well over a year.

What's also interesting is that PIMCO is trying to nickel and dime the holders. They are offering prices of 93-94 cents on the dollar for these. Recall that ARPS holders have been trapped since the GFC because auctions for these have continued to fail, meaning holders cannot get rid of them.

However, at this point the holders are basically earning yields of B-/CCC+ corporate bonds for holding very high-quality (roughly AA) securities. Unless the holders are in a liquidity crunch why would they sell these securities especially for less than par?

Had PIMCO held a tender offer in 2022, not only would they have received more interest from holders due to lower interest rates on the ARPS (or the same interest but at a lower price) but they wouldn't have had to overpay for leverage all this time. Clearly, there are some reasons for doing a tender offer this late in the game however we don't expect PIMCO to share them.

Takeaways

We continue to stay clear of the PIMCO funds due to relatively high valuations. The average PIMCO taxable premium is on the order of 14%. The suite also looks expensive relative to the rest of the CEF market, trading around 22% more expensive.

We see better value in other multi-sector funds like the Western Asset Diversified Income Fund ( WDI ), the Western Asset Mortgage Opportunity Fund ( DMO ) and the Nuveen Mortgage and Income Fund ( JLS ), all of which have outperformed the PIMCO taxable CEFs this year in total NAV terms (JLS has only failed to outperform PTY on this metric).

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