 |
|
Dear Fellow Shareholders,
Throughout the first half of 2008, the U.S. economy and financial markets continued to grapple with the fall-out of the crises in the sub-prime mortgage and collateralized debt obligation markets that began a year ago. The effects of the credit crisis, reduced liquidity, and concerns about a recession have resulted in greater volatility and uncertainty in the high yield bond market. While the Fund's investment adviser, T. Rowe Price Associates, Inc. ("TRP" or the "Adviser"), has invested the portfolio in a relatively defensive posture within the high yield bond universe, the net asset value (the "NAV") of the portfolio has declined with the market. The decline in the market price of the Fund's shares has been greater than the decline in the NAV due to high yield investors demanding a greater risk premium. The Adviser continues to monitor closely the Fund's portfolio and believes that the portfolio is appropriately positioned in the current environment. During the first half of the year there was only one new issuer default out of the hundreds of issuers in the portfolio.
In our past shareholder reports, we have discussed the Fund's leverage which is in the form of an Auction Term Preferred Stock (the "ATP"). The ATP provides a relatively low-cost way for the Fund to leverage, which enables the Fund to pay a higher common stock dividend than would otherwise be possible. The dividend rate the Fund must pay on the ATP resets monthly through an auction procedure and has generally floated around one month LIBOR (London Interbank Offered Rate), a widely used money market reference rate. Unfortunately, as we reported in our last shareholder letter, the disruptions in the financial markets resulted in a significant reduction in the number of investors willing to buy the auction rate securities of most issuers, including closed-end funds like ours. In an unprecedented development, since February the auctions for most auction rate securities, including the Fund's ATP have failed. As a result of the auction failures, the holders of the Fund's ATP have not been able to sell the ATP. In a failed auction, the ATP dividend is set according to the terms of the ATP prospectus at 150% of the AA-rated 30 day commercial paper rate. As a result of the failed auction on June 30, 2008, the ATP dividend was set at 3.623%. The ATP continue to be rated Aaa/AAA by Moody's Investor Services and Fitch. The Fund's leverage and a related interest rate swap contributed approximately 15% of the common stock dividend as of June 30, 2008. Of course, the Fund's use of leverage is not without risk. The Fund's leverage increases the volatility of the Fund's NAV, and if the high yield bond market declines significantly, the Fund may have to reduce the leverage and reduce the common stock dividend.
Although the Fund has been and is in compliance with the terms of the ATP, The Fund's Board continues to examine potential solutions to the liquidity crises affecting the Fund's ATP investors, bearing in mind that before taking any action in this area they must determine that it is in the best interest of the Fund as a whole.
Performance Update
The Fund paid monthly dividends totaling $.07 per share during the first half of 2008.
Of course, in the future, the dividend may fluctuate, as it has in the past, depending upon portfolio results, the cost of leverage, market conditions, and other factors.
The Fund's net asset value per share (the "NAV") ended the period at $1.81. The market price for the Fund's shares on the New York Stock Exchange closed at $1.60 on June 30, 2008, representing a market price discount of 11.6% from the NAV. During times of market turmoil, it is common for the market price discount to the NAV to widen as investors demand a greater risk premium.
| |
Total Returns for the Period Ending
June30, 2008 |
| |
1 Year |
3 Years Cumulative |
New America High Income Fund
(Stock Price and Dividends)* |
(18.79%) |
2.17% |
New America High Income Fund
(NAV and Dividends) |
(6.68%) |
14.85%) |
| Lipper Closed-End Fund Leveraged High Yield Average (NAV and Dividends) |
(15.66%) |
4.16%) |
| Credit Suisse High Yield Index |
(2.12%) |
215.25% |
| Citigroup 10 Year Treasury Index |
12.57% |
11.37% |
Sources: Credit Suisse, Citigroup, Lipper, The New America High Income Fund, Inc.
Past performance is no guarantee of future results. Total return assumes the reinvestment of dividends.
*Because the Fund's shares may trade at either a discount or premium to the Fund's net asset value per share, returns based upon the stock price and dividends will tend to differ from those derived from the underlying change in net asset value and dividends.
High Yield Market Update
The environment for high yield bonds turned ugly over the past six months. The challenges, both at the macro level-relating to the economy and capital markets-and issues specific to the asset class, created the worst environment for high-yield investing in recent memory. Although defaults remained at historically low levels, yields on high-yield bonds surged to a wide premium over risk-free Treasuries, and the asset class has witnessed a dramatic increase in volatility. Despite a significant rally in high yield bonds in March and April on the back of JP Morgan's purchase of Bear Stearns and additional emergency measures by the Fed and other government agencies to stabilize the financial system, investors continue absorb large aftershocks from the credit crisis impacting the marketplace. In what was widely feared to be a replay of the Bear Stearns episode, Lehman Brothers came under heavy suspicion during the second quarter with respect to the accuracy of the marks on its balance sheet. Investors have come to expect that banks and brokers, both large and small, face additional write-downs and will need fresh capital. Demonstrating troubles in the broader economy, confidence among US consumers fell in May to the lowest level in almost 28 years and consumers and businesses a like are struggling under the dual burden of rising commodity costs and a slowing economy.
As measured by the Credit Suisse High Yield Index, the market for high yield bonds is down 1.14% for the six month period ended June. This modest loss masks the wide swings witnessed over the time period. For the first quarter the market was down nearly 3.00%, including a 1.65% decline in January, before racing back, with April's nearly 4.00% gain absorbing all the losses for the year. May delivered an additional positive contribution of roughly .40%, before the June decline of 2.41%. The adverse move in spreads for high yield bonds (a measure of their yield advantage versus Treasuries, expressed in basis points) was equally dramatic. On July first of 2007, the high yield market stood at a spread of 326 basis points over Treasuries as measured by the JP Morgan High Yield Index, one broadly watched market barometer. This Index ended June 2008 at a spread of 713 basis points, a 387 basis point change that included a sprint to 842 basis points over Treasuries in the days leading up to the Bear Stearns rescue and 214 basis points of tightening after the broker was pushed into the arms of JP Morgan. By this measure, the market stands 123 basis points wider at the end of June than where it began the year. Each 20 basis point change in spread equates to roughly 1 bond point, or $10 per $1,000 of par. When coupled with six months worth of annual coupon income of approximately 10%, the 123 basis points of spread widening - roughly a 6% loss in principal - nets to first half performance of a negative 1% for the broader market. This compares with a 12.82% decline in stocks over the same period, as measured by the S&P 500 Index, and a 2.08% gain for the 10 year Treasury, according to Citigroup.
Strategy Update
The difficult climate of the past six months has presented both challenges and opportunities. Among the challenges, many of the bonds associated with the mega cap leveraged buyouts (LBOs) of recent years declined significantly in price. Concurrently, many bonds for companies we have concluded to be sound from a credit perspective are available at attractive yields and some recent deals have included valuable collateral or attractive terms not seen in many years.
One name in the portfolio we elected to reduce exposure was the restaurant company Outback Steakhouse. While we like the company's portfolio of brands and think they are positioned to endure through all but the most severe of recessions, the bonds carried a high level of volatility that we felt was only going to grow in intensity with the consumer outlook remaining so challenging. During the quarter we also made a meaningful reduction in the portfolio's exposure to General Motors. The auto sector faces a very challenging climate and GM and Ford are among the most difficult investments our team has ever had to analyze.
Despite the crisis playing out across the fixed income markets, we continue to look for ways to capitalize and invest the fund's assets. For example, we own two shorter-dated maturities in investment grade-rated SLM, commonly known as Sallie Mae, one due in 2009 and one due in 2011. At the time of purchase, the 2011 issue offered a 9.00% yield, and while the market for student lending faces enormous challenges, in our view the company is amply solvent through the life of these bonds. Recently, home builder K. Hovnanian and discount online broker E-Trade approached the high yield market in need of capital to address challenges on their balance sheets. While these deals came with greater stigma than most high yield offerings, they also offered attractive collateral, ranked high in the capital structure and provided attractive yields. The Hovnanian issue is rated Ba3/B+ by Moody's and S&P. E-Trade's latest debt offering is not currently rated by the major agencies, but it carries a springing lien that ranks it ahead of the company's older Ba3/B rated issues. Situations like these do not require us to reach to the very bottom of the credit quality spectrum to earn high rates of income and they are secured by attractive collateral. As of the June month-end, both bonds traded at a premium, reflecting the companies' moderately improved prospects. The Hovnanian issue has a coupon of 11.50% and yields 10.42% while E-Trade's issue carries a 12.50% coupon and yields 11.00%. We expect to have the opportunity to pursue more bonds like these in the months ahead.
Overall, the portfolio remains defensively postured and we have achieved this through a variety of tactics. We have continued to emphasize defensive industries, overweighting utilities, energy, service and healthcare companies while de-emphasizing consumer related industries including homebuilders, retailers and consumer products companies. We have sought to play shorter-dated maturities as they tend to behave defensively in a volatile market. We have also looked to reduce the portfolio's sensitivity to an adverse move in rates by continuing to emphasize bank debt and floating rate instruments, combined they now represent nearly 10% of the fund's holdings. While these floating rate securities hurt performance in January in the face of aggressive rate cuts from the Fed, they have been among our best performing holdings in the second quarter as the market began anticipating the threat of higher interest rates. We think they help insure the portfolio against the damaging effects of a sharp move in Treasuries off historically low levels.
Outlook
In what we hope is the beginning of a significant trend, June brought the return of merger and acquisition activity in high yield, and this time the buyers were not private equity firms intent on levering up their prey but corporate buyers pursuing credit enhancing strategic transactions. We began the month with news that one the portfolio's largest holdings, CCC-rated Alltel, would be acquired by AA-rated Verizon Wireless. Perhaps most stunning about this transaction is that Alltel had been through a leveraged buyout within the last year. The pleasant surprises continued during the month with word that PNA was to be acquired by Reliance and Allied Waste was merging with Republic Services. The Fund's holdings in PNA and Allied gained sharply on these announcements. We're encouraged that the transactions confirmed our credit work and we hope that it is the beginning of a significant trend. In each of these deals the buyers were of higher credit quality than their targets. Perhaps now that corporate managements are no longer competing with inflated bids from the private equity firms they will be willing to pursue credit and value enhancing strategic transactions.
Aside from this recent positive development, the high yield market has much to be concerned about, including the specter of inflation and rising cost pressures as well as lingering concerns about the health of the financial system and broader economy. We expect corporate defaults will rise in this climate and indeed through May they have surpassed the rate achieved for all of last year. Market forecasters anticipate defaults will rise steadily throughout the year, perhaps to 2 to 3%, before peaking in 2009 at around 8%. In our view, high yield spreads have further to go to price in this prospect, but we remain mindful that spreads have historically tended to come in dramatically before the default rate peaks. In the meantime, we will look to short-dated, high yielding situations for opportunities, with the focus as always on the Fund's investment objective of providing high current income, while seeking to preserve principal.
Sincerely,
Robert F. Birch
President
The New America High Income Fund, Inc. |
Mark Vaselkiv
Vice President
T. Rowe Price Associates, Inc. |
| |
Ellen E. Terry
Vice President
The New America High Income, Inc. |
Paul Karpers
Vice President
T. Rowe Price Associates, Inc. |
The views expressed in this update are as of the date of this letter. These views and any portfolio holdings discussed in the update are subject to change at any time based on market or other conditions. The Fund and T. Rowe Price Associates, Inc. disclaim any duty to update these views, which may not be relied upon as investment advice. In addition, references to specific companies' securities should not be regarded as investment recommendations.
|
