GDV: Attractive preferred shares of this CEF (NYSE: GDV.PK)

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Thesis

The Gabelli Dividend and Income Trust (NYSE: GDV.PK) is a closed-end fund focused on US equities. The fund’s primary investment objective is total return. GDV is posting remarkably robust long-term results and has an accretive net asset value that has grown at a CAGR of 5% over the past decade. The CEF has a low leverage of 17%, obtained mainly through the issuance of preferred shares.

There are several ways for a CEF to gain leverage:

  • Repurchase agreements
  • TRS (Total Return Swap) facilities
  • Preferred shares (bidding rate, fixed rate, etc.)

The best futures option is the preferred stock route, as it usually has no stated maturity. Preferred shares are usually issued with a non-redemption period of five years and some market participants tend to use this date as their maturity date. Usually this doesn’t work like clockwork, with most funds simply arbitrating market conditions – if they are able to place new preferred stocks at better yields, they will do so and retire the old ones. If not, the “old” favorite will not be removed.

Repurchase agreements and TRS facilities offer greater flexibility in terms of leverage a fund up or down since they have shorter tenors (Repos) or in the case of undrawn TRS commitments (i.e. the fund does not need to use all of the borrowing on day 1, and can add or subtract assets within a certain net balance framework).

When an investor looks at CEF preferred stocks, they should be framed in the same configuration as high-quality corporate bonds. Successful CEFs with excellent asset coverage ratios such as GDV will earn very high investment grade ratings for their preferred shares and they will have established a very strong history of issuing and redeeming those shares. GDV’s Series K is the latest preferred issue, and it was used to retire a more expensive slice of the capital structure, namely Series G.

Rated Aa3 by Moody’s, Series K has a coupon of 4.25% and a yield of 5.22%. The shares are redeemable from October 2026, but we believe that due to its low coupon, the shares will be outstanding longer. We consider these titles as a 6 year duration game. For a retail investor looking for a stable source of income from a highly rated security, this is a good yield play. In our view, there is no credit risk associated with Series K, only interest rate risk. Currently trading at Treasuries + 200 bps Series K is attractively priced relative to, for example, volatile dividend-paying stocks. We believe Series K should be bought on declines by retail investors looking to hold the stock for 3+ years. As interest rates peak, Series K price bottoms out with significant upside potential ahead.

GDV capital structure

The current capital structure of the fund is as follows:

facts

Capital structure (Fact sheet)

The more expensive Series G preferred shares were retired when Series K was issued. We can see that the fund uses a modest leverage ratio of around 17%.

Characteristics of Series K Preferred Shares

The series was issued in October 2021 and was used to withdraw another tranche of preferred shares from GDV:

The Fund intends to use a portion of the net proceeds of this Offering to redeem all or a portion of the outstanding Series G Preferred Shares of the Fund. The Fund intends to redeem all or a portion of the Series G Preferred Shares within three months of the completion of this offering.

Source: Prospectus

The shares are not callable (except in cases of force majeure) until October 2026:

The Series K Preferred Shares are generally not redeemable at the option of the Fund prior to October 7, 2026. The Fund, however, reserves the right to redeem the Series K Preferred Shares at any time if necessary, as determined by the Board. , to maintain its status as a regulated investment company (an “RIC”) under Subchapter M of the Internal Revenue Code of 1986, as amended (the “Code”). The Fund may also be required, in certain circumstances, to redeem Series K Preferred Shares before or after October 7, 2026, in order to comply with certain regulatory or rating agency asset coverage requirements.

Source: Prospectus

At issuance, Series K’s coverage ratio was over 600%, leading to its very high Investment Grade rating from Moody’s (rated Aa3):

In accordance with the 1940 Act, the Fund will generally not be permitted to declare a dividend or to declare any other distribution on outstanding ordinary shares, to purchase ordinary shares or to issue preferred shares, unless in each case , all preferred shares issued by the Fund have, at the time of declaration of such dividend or distribution or at the time of such purchase or issue, an asset coverage of at least less 200% (“1940 Act Asset Cover Requirement”) after deducting the amount of such dividend, distribution or purchase price, as the case may be. As of the date of this Prospectus Supplement, all of the outstanding preferred shares of the Fund are expected to have an asset coverage at the date of issue of the Series K Preferred Shares of approximately 668%

Source: Prospectus

Credit risk

The K series are highly rated by Moody’s:

Evaluation

Rating from Moody’s (Moody’s)

Aa3 is one of the highest ratings. As a reminder, here is what the grading scale looks like:

Evaluation

Credit ratings (Credit)

Given the large asset coverage and unleveraged profile, Series K has a very low probability of default.

Interest rate risk

This is where all the risk associated with preferred shares lies. Being the last issue of the trust and carried out at a very low attractive fixed rate, Series K will have a long duration. We do not expect the shares to be redeemed on their first redemption date in October 2026, unless we see another zero rate environment. This series was placed at a very attractive yield for the trust.

The series is currently trading at a yield of 5.22%, which in the current setup is Treasuries + about 200 bps:

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Investment Grade Bond Spreads (The Fed)

We can see that the current BBB-grade corporate bond spread is close to around 2%, having widened following the risk sell-off. However, the main component of the GDV.PRK return is the risk-free rate component, where we use 5-year Treasury bills as a benchmark.

Conclusion

Series K is the latest issue of preferred shares from the GDV Trust. Highly rated at Aa3, the securities are attractive play for a buy and hold investor. The main pricing drivers are interest rates and the high duration of the series (we rate it as a 6-year bond despite the October 2026 purchase date). Currently priced at Treasuries + 200 bps, the series offers an attractive yield of 5.22% versus stocks paying much more volatile dividends. If you are looking to extract returns above 5% with virtually no default risk and minimal volatility, GDV.PRK is an attractive choice.

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