Fitch Affirms Preferred Share Ratings of 4 PIMCO Closed End Funds at 'AAA'

Fitch Ratings has affirmed the 'AAA' ratings assigned to the auction rate preferred shares (ARPS) issued by the following four closed-end funds sub-advised by Pacific Investment Management Company LLC (PIMCO):

PIMCO High Income Fund (NYSE: PHK)

--$292,000,000 of ARPS consisting of Series M, T, W, TH and F, each with a liquidation preference of $25,000 per share, affirmed at 'AAA';

PIMCO Corporate & Income Strategy Fund (NYSE: PCN)

--$169,000,000 of ARPS consisting of Series M, T, W, TH and F, each with a liquidation preference of $25,000 per share, affirmed at 'AAA';

PIMCO Income Strategy Fund (NYSE: PFL)

--$78,975,000 of ARPS consisting of Series T, W and TH, each with a liquidation preference of $25,000 per share, affirmed at 'AAA';

PIMCO Income Strategy Fund II (NYSE: PFN)

--$161,000,000 of ARPS consisting of Series M, T, W, TH and F, each with a liquidation preference of $25,000 per share, affirmed at 'AAA'.

KEY RATING DRIVERS

The affirmations follow Fitch's annual reviews of the funds. The 'AAA' ratings are based on sufficient asset coverage provided to the ARPS by the funds' underlying portfolios of assets, the structural protections afforded by mandatory cure and de-leveraging provisions in the event of asset coverage declines, the legal and regulatory parameters that govern the funds' operations and the capabilities of PIMCO as the sub-advisor. Fitch's ratings assigned to the ARPS speak only to timely repayment of interest and principal in accordance with the governing documents and not to potential liquidity in the secondary market.

LEVERAGE

As of Jan. 31, 2012, the funds had the following assets and cash leverage outstanding:

--PHK: total portfolio assets of approximately $1,300 million, current liabilities of $23 million and cash leverage of $350 million, or 27% of net portfolio assets. Cash leverage consisted of approximately $58 million of reverse repurchase agreements and $292 million of rated ARPS. Fitch's criteria also consider the fund's use of economic leverage in the form of derivatives, which amounted to $33 million in notional of credit default swaps and excess (unhedged) forward currency exposures.

The Fund also utilized interest rate swaps with a notional amount of $1,350 million for current income, while hedging the majority of the interest rate risk with offseting six-month to two-year forward swaps. Fitch notes that although the net duration contribution to the portfolio appears immaterial, a large notional exposure is nevertheless retained exposing the fund to a small segment of the forward yield curve. Fitch views the market value risk of this exposure as being contained within the current asset coverage of the fund but will reassess upon any material adverse changes to the strategy and/or declines to the asset coverage of the fund.

--PCN: total portfolio assets of approximately $815 million, current liabilities of $17 million and cash leverage of $293 million, or 37% of net portfolio assets. Cash leverage consisted of approximately $124 million of reverse repurchase agreements and $169 million of rated ARPS. Fitch's criteria also consider the fund's use of economic leverage in the form of derivatives, which amounted to $39 million in notional of credit default swaps and excess (unhedged) forward currency exposures.

--PFL: total portfolio assets of approximately $398 million, current liabilities of $2 million and cash leverage of $135 million or 34% of net portfolio assets. Cash leverage consisted of approximately $56 million of reverse repurchase agreements and $79 million of rated ARPS. Fitch's criteria also consider the fund's use of economic leverage in the form of derivatives, which amounted to $11 million in notional of credit default swaps and excess (unhedged) forward currency exposures.

--PFN: total portfolio assets of approximately $792 million, current liabilities of $5 million and cash leverage of $237 million, or 30% of net portfolio assets. Cash leverage consisted of approximately $76 million of reverse repurchase agreements and $161 million of rated ARPS. Fitch's criteria also consider the fund's use of economic leverage in the form of derivatives, which amounted to $20 million in notional of excess (unhedged) forward currency exposures.

ASSET COVERAGE

As of the same date, the funds' asset coverage ratios, as calculated in accordance with the Fitch total and net overcollateralization tests (Fitch OC tests) per the 'AAA' rating guidelines outlined in Fitch's closed-end fund criteria, were in excess of 100%, which is the minimum asset coverage amount deemed consistent with an 'AAA' rating per Fitch's criteria. The funds' governing documents require that asset coverage for the ARPS, as calculated in accordance with the Fitch OC tests, be maintained in excess of 100%. As such, should the asset coverage decline below 100%, the governing documents require the funds to alter the composition of their portfolio toward assets with lower discount factors, or to reduce leverage in a sufficient amount to restore compliance within a 38 business day period.

On Aug. 16, 2011, Fitch published an update to its closed-end fund rating criteria that includes several changes to the way Fitch OC test is calculated. The effect of these changes is a small decrease in Fitch OC tests across the funds, although still maintained in excess of 100%. Pimco expects to finalize changes to the ARPS documents that incorporate the changes to updated criteria in the near future, subject to approval by the funds' board of directors. In the mean time, Fitch has extended a grace period to the funds given the high asset coverage, but may take rating action sooner if asset coverage declines before the changes are adopted.

Additionally, as of the same date, the funds' asset coverage ratios for total outstanding ARPS, as calculated by PIMCO in accordance with the Investment Company Act of 1940, were in excess of 200%, which is also a minimum asset coverage required by the funds' governing documents.

FUND PROFILES

As of Jan. 31, 2012, the portfolios consisted mainly of high-yield and investment grade corporate securities, structured finance securities, preferred stock and taxable municipal bonds issued by U.S. domiciled issuers. The PCN fund had a higher allocation of investment grade corporate securities while the other three funds had a higher allocation to high-yield corporate securities The top sector concentration for each fund was in 'Banking, Finance and Insurance', exceeding the 25% guideline per Fitch's criteria in each fund. Exposure in excess of Fitch's industry concentration guidelines received an additional discount factor multiple of 1.5 times for purposes of calculating the Fitch OC tests. Top issuer concentrations for PHK, PFN and PCN funds were in excess of Fitch 10% each guideline, as well. Exposure in excess of Fitch's issuer guidelines receives no credit for purposes of calculating the Fitch OC tests. The effect of these excess concentrations was a decrease in the Fitch Total and Net OC tests, although the tests all remained in excess of 100%. The funds are diversified, closed-end management investment companies, registered under the Investment Company Act of 1940.

THE ADVISOR

PIMCO acts as the sub-adviser to the funds, performing all investment management and distribution functions. As of Dec. 31, 2011, PIMCO had $1,357 billion in assets under management. Allianz Global Investors Fund Management, LLC (AGIFM) acts as the advisor to the fund, performing all legal, operations and compliance functions. PIMCO and AGIFM are indirect, majority owned subsidiaries of Allianz SE.

RATING SENSITIVITY

The ratings may be sensitive to material changes in the credit quality or market risk profiles of the fund. Ratings of PHK ARPS are also sensitive to any adverse changes in the risk exposure assumed by the fund's use of interest rate swaps. A material adverse deviation from Fitch guidelines for any key rating driver could cause the rating to be lowered by Fitch. Furthermore, ratings are sensitive to the funds' adoption of mandatory cure and deleveraging provisions consistent with the 'AAA levels' described in Fitch's updated Aug. 16, 2011 closed-end fund criteria. For additional information about Fitch closed-end fund ratings guidelines, please review the criteria referenced below, which can be found on Fitch's website.

Additional information is available at 'www.fitchratings.com'. The ratings above were solicited by, or on behalf of, the issuer, and therefore, Fitch has been compensated for the provision of the ratings.

The sources of information used to assess this rating were the public domain, PIMCO and AGIFM.

Applicable Criteria and Related Research:

--'Rating Closed-End Fund Debt and Preferred Stock' (Aug. 16, 2011);

--'Closed-End Funds: Derivatives Under Review (Increased Use and Limited Transparency Are Key Considerations)' (Nov. 16, 2011);

--'2012 Outlook: Closed-End Fund Leverage' (Dec. 19, 2011).

Applicable Criteria and Related Research:

Rating Closed-End Fund Debt and Preferred Stock

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=648840

Closed-End Funds: Derivatives Under Review (Increased Use and Limited Transparency Are Key Considerations)

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=656591

2012 Outlook: Closed-End Fund Leverage

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=660709

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Contacts:

Fitch Ratings
Primary Analyst
Yuriy Layvand, CFA, +1-212-908-9191
Director
Fitch, Inc.
One State Street Plaza
New York, NY 10004
or
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Gwen Fink-Stone, +1-212-908-9128
Associate Director
or
Committee Chairperson
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Senior Director
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Email: brian.bertsch@fitchratings.com
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