VIRTUS DIVERSIFIED INCOME & CONVERTIBLE FUND
Fitch Ratings has affirmed the 'A' long-term (LT) ratings assigned to the senior secured notes (notes) and the Series A Mandatory Redeemable Preferred Shares (MRPS) issued by
Fitch has also affirmed the 'A' LT ratings assigned to the Series A Cumulative Preferred Shares issued by
KEY RATING DRIVERS
The ratings are supported by:
Suf?cient asset coverage provided to the rated securities as calculated per each funds' asset coverage tests (please see Rating Sensitivities below for additional information).
The structural protections afforded by mandatory collateral maintenance and deleveraging provisions in the event of asset coverage declines.
The legal and regulatory parameters that govern the funds' operations.
The capabilities of
Fitch's ratings assigned to the ARPS speak only to timely repayment of dividends and liquidity preference in accordance with the governing documents and not to potential liquidity in the secondary market.
FUND PROFILES
The funds are diversi?ed, closed-end management investment companies, registered under the Investment Company Act of 1940, as amended.
ACV's investment objective is to provide total return through a combination of current income and capital appreciation, while seeking to provide downside protection against capital loss. Under normal market conditions, the fund will seek to achieve its investment objective by investing in a combination of convertible securities, debt and other income-producing instruments and common stock and other equity securities. The fund expects to normally employ a strategy of writing (selling) covered call options on the shares held in the equity portion of the portfolio.
NCV's investment objective is to provide total return through a combination of capital appreciation and high current income. Under normal circumstances, the fund will invest at least 80% of its total assets in a diversi?ed portfolio of convertible securities and non- convertible income-producing securities.
NCZ's investment objective is to provide total return through a combination of capital appreciation and high current income. Under normal circumstances, the fund will invest at least 80% of its total assets in a diversi?ed portfolio of convertible securities and non- convertible income-producing securities.
ASSET COVERAGE
As of the review date, ACV's asset coverage ratios for the notes and MRPS, as calculated in accordance with the Fitch total and net overcollateralization tests (Fitch OC tests) per the 'A' rating guidelines outlined in Fitch's Closed-End Fund Criteria, were in excess of 100%.
This is the minimum asset coverage guideline required by the transaction documents governing the notes and MRPS. In addition, ACV's indebtedness and MRPS are subject to asset coverage requirements of 300% and 200%, respectively, under the transaction documents governing the notes, and the MRPS are subject to an asset coverage requirement of 225% pursuant to the transaction documents governing the MRPS.
As of the review date, NCV and NCZ's asset coverage ratio for the rated cumulative preferred shares, as calculated in accordance with the Fitch OC tests per the 'A' rating guidelines outlined in Fitch's applicable criteria, were in excess of 100%. This is the minimum asset coverage guideline required by the fund's governing documents. Also, at the time of the af?rmation, NCV's asset coverage ratio for total leverage, as calculated in accordance with the 1940 Act, was in excess of 200%, which is the minimum asset coverage required by the 1940 Act and the fund's governing documents.
As of the review date, NCZ's asset coverage ratio for rated ARPS, as calculated in accordance with the Fitch total and Fitch OC tests per the 'A' rating guidelines outlined in Fitch's applicable criteria, was in excess of 100%. This is the minimum asset coverage guideline required by the fund's governing documents. Also, at the time of the af?rmation, NCZ's asset coverage ratio for rated ARPS, as calculated in accordance with the 1940 Act, was in excess of 200%, which is the minimum asset coverage required by the 1940 Act and the fund's governing documents.
The Fitch OC tests calculate standardized asset coverage by applying haircuts to portfolio holdings based on riskiness and diversi?cation of the assets and measuring their ability to cover both on- and off-balance-sheet liabilities at the stress level that corresponds to the assigned rating. Fitch OC tests also capture the funds' use of synthetic convertible securities based on the credit rating of the issuer and put provider, the provisions on put protection and stock delta, and whether underlying stock is trading at an equity-sensitive, typical or busted conversion premium, similar to a straight convertible position.
NOTES' STRUCTURAL PROTECTIONS
Should the asset coverage tests decline below their minimum threshold amounts (as tested on the last business day of each week, in the case of rating agency tests, or each month, in the case of the asset coverage tests), under the terms of the notes, ACV is required to deliver notice to the note purchasers within ?ve business days. The fund's managers are then expected to cure the breach by altering the composition of the portfolio toward assets with lower discount factors (for Fitch OC tests breaches), or by reducing leverage in a suf?cient amount (for both the Fitch OC tests and the 1940 Act test breaches) within a pre-speci?ed period as set forth in the applicable governing document. The pre-specified time period provided for in the applicable governing document is consistent with Fitch's criteria guidelines.
Failure to cure an asset coverage breach as described above is an event of default under the terms of the notes. The fund must then deliver a notice within ?ve business days to the note purchasers, and a vote of holders of at least 51% of the principal amount of the notes may then declare all the notes then outstanding to be immediately due and payable.
The fund is also prohibited from declaring or paying out a common stock dividend or other distribution on common shares unless, immediately after such transaction, the applicable fund would satisfy the 300% asset coverage test on indebtedness. Fitch views this as an added incentive to cure and deleverage in a timely manner, regardless of acceleration by the notes' purchasers.
ARPS STRUCTURAL PROTECTIONS
Should the asset coverage test results of the ARPS issued by NCZ decline below their minimum threshold amounts (as tested on the last business day of each week), the governing documents require the fund to alter the composition of its portfolio toward assets with lower discount factors (for Fitch OC tests), or to reduce leverage in a suf?cient amount (for both the Fitch OC tests and the 1940 Act test) to restore compliance within a pre-speci?ed period as set forth in the applicable governing document. The pre-specified time period provided for in the applicable governing document is consistent with Fitch's criteria guidelines. In addition, the fund is prohibited from declaring or paying a cash distribution if the fund breaches either asset coverage test. If the breach of the 1940 Act test is not cured within the necessary timeframe, the ARPS would be subject to a mandatory redemption.
MRPS STRUCTURAL PROTECTIONS
Should the asset coverage test or the Fitch OC test results of the MRPS issued by ACV decline below their minimum threshold amounts (as tested weekly, in the case of rating agency tests, or monthly, in the case of the asset coverage tests).
The fund is required to cure the breach by altering the composition of the portfolio toward assets with lower discount factors (for Fitch OC test breaches), or by reducing leverage in a suf?cient amount (for both the Fitch OC tests and MRPS documents asset coverage test breaches) within a pre-speci?ed period as set forth in the applicable governing document. The pre-specified time period provided for in the governing document is consistent with Fitch's criteria guidelines.
CUMULATIVE PREFERRED SHARES' STRUCTURAL PROTECTIONS
Should the asset coverage test results of the NCV or NCZ series A cumulative preferred shares decline below their minimum threshold amounts, the respective governing documents require the applicable fund to reduce leverage in a suf?cient amount (for both the Fitch OC tests and the 1940 Act test) to restore compliance within a pre-speci?ed period, subject to cure provisions and various other terms and conditions.
For as long as Fitch rates the series A cumulative preferred shares of NCV, the fund will be required to assess its compliance with the Fitch OC tests on the last business day of each month. For as long as Fitch rates the series A cumulative preferred shares of NCZ, the fund will be required to assess its compliance with the Fitch OC tests on the last business day of each month. Both funds are required to assess its compliance with the 1940 Act 200% asset coverage test with respect to preferred stock on the last business day of each quarter.
The maximum market risk exposure period for the series A cumulative preferred shares of NCV and NCZ slightly exceed the 40 to 60 business day exposure period contemplated by the discount factors in Fitch's published rating criteria. Fitch performed additional analysis comparing worst losses observed over 62 business days to those used to derive the discount factors in published criteria for convertible and corporate bonds. Fitch determined that the differences in worst losses were not material and the difference between a 62 business day exposure period and a 60 business day exposure period was not material. The published discount factors were applied in the analysis as a result.
INVESTMENT MANAGER
AGIUS is the funds' subadviser.
RATING SENSITIVITIES
Factors that could, individually or collectively, lead to positive rating action/upgrade:
Ratings upgrades are not currently envisioned as the funds invest largely in securities that are ineligible for credit at the 'AA' rating level.
Factors that could, individually or collectively, lead to negative rating action/downgrade:
The ratings may be sensitive to material changes in the leverage composition, portfolio credit quality or market risk of the funds' assets, as described above. A material adverse deviation from Fitch guidelines for any key rating driver could cause Fitch to downgrade the ratings;
The ratings could be downgraded if asset coverage cushions erode as a result of market volatility, or if Fitch believes the assets the fund invests in are unlikely to retain suf?cient liquidity and price stability at the current rating stress levels;
While ACV's notes and MRPS are currently equalized at the 'A' rating level, further differentiation between classes is possible in the future based on seniority;
Transaction documents reference Fitch's rating criteria that was published in
Best/Worst Case Rating Scenario
International scale credit ratings of Financial Institutions and Covered Bond issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from '
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