3: Regulatory Leverage
Regulatory leverage is leverage as defined by the Investment Company Act of 1940,
Regulatory leverage is always considered to be structural – ie, an intentional part
of a fund’s design and capital structure.
Regulatory leverage includes borrowings or debt issued by the fund, as well as various
types of preferred shares (equity). Both of these change a fund’s
capital structure by introducing additional capital that is senior to a
fund’s common shares. This seniority means that all interest payments for debt and
all declared preferred share dividends must be paid before any common share dividends
are paid. If a fund is liquidated, the proceeds pay borrowings/debt principal first,
then preferred shareholders, with the remainder going to common shareholders.
Unless a fund’s prospectus describes stricter leverage limits, the ’40 Act limits
regulatory leverage:
- Is a strategic part of a fund's overall structure
- Creates a systematic level of additional investment exposure
Types of regulatory leverage include (but are not limited to):
- Debt: Borrowings or debt issued by a fund
Regulations for debt leverage require that the value of assets (capital) raised
by borrowing must be backed (covered) by the total value of portfolio assets at
least 3 to 1. In other words, the fund’s maximum debt leverage is 33%.
- Equity (Preferred Shares)
Regulations for equity leverage require that preferred share assets be backed by
total portfolio assets at least 2 to 1, meaning maximum equity leverage is 50%.
- Variable-rate demand preferred shares (VRDP)
- MuniFund Term Preferred (MTP)
- Variable MuniFund Term Preferred (VMTP)
Click on each type for more details.
- Fund borrows from bank or other firm. Terms vary, including whether interest payments
are fixed or adjustable, as well as timeframes.
- Can be auction-rate notes, line of credit, commercial paper, and other forms of
debt.
- A form of preferred share first issued by some Nuveen funds in August 2008.
- VRDP was designed to be eligible for money market funds to purchase
- Each fund is expected to maintain high credit ratings from nationally recognized
rating agency for the VRDP shares
- Shares have been issued in private placements; shares have not been registered with
the SEC.
- Dividends are set by a remarketing agent each week.
- Shares include a liquidity feature (a put option) paid for by the fund.
- If shares cannot successfully be remarketed, the liquidity provider is obligated
to buy the shares and dividend rates are set by formulae described in the shares’
offering documents.
- If unsuccessful remarketing persists,
- Dividends progressively increase [each month] in order to try to attract buyers
for the shares
- After 6 months of unsuccessful remarketing, the fund is obligated to buy back the
VRDP shares from the liquidity provider.
- A form of preferred share that seeks to lock in leverage costs for a stated term
- Fixed term (3 to 5 years) with mandatory redemption, callable by the fund after
1 year
-
Structured Liquidity Plan to fund MTP redemption
- Fixed-rate monthly tax-exempt dividends
- High quality credit ratings upon issuance
- $10 denomination (liquidation preference)
- NYSE exchange listing offers, but does not guarantee, liquidity prior to the mandatory
redemption date
- Additional information at MTP microsite
- Similar to fixed-rate MTP, Variable MuniFund Term Preferred is a form of
preferred share with a fixed term, first offered by Nuveen funds in March 2011.
- Fixed term (3 to 5 years) with mandatory redemption, callable by the fund after
1 year
-
Structured Liquidity Plan to fund MTP redemption
- Variable rate tax-exempt dividends
- Shares issued in private placement and thus not registered for retail investment.
Next: Leverage from Portfolio
Investments