Note On Closed-end Leveraged Muni Bond Funds

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Note On Closed-end Leveraged Muni Bond Funds
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I’ve received two notes recently on Closed-end Leveraged Muni Bond Funds.  Here’s one:

Note On Closed-end Leveraged Muni Bond Funds

David,

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I have been asked several times about the Blackrock Target Term Municipal Bond Trust (“BTT”).  The appeal is obvious:  at $17, it offers a 7% tax free yield.  A theoretical $25 redemption price in about 15 years adds roughly 2.5% per year to the total return (not tax free, but at least tax deferred).

All wonderful stuff.  What I do not understand is the leverage via Tender Option Bonds.  I realize TOB’s equate to borrow short/lend long, which has obvious risks, but the range of outcomes and probabilities is beyond me.

Can you shed some light on this?

And here is the other:

What about the closed end funds of Eaton Vance that are trading at a discount to their nav? I’m thinking specifically of the muni one EIV?

Also do you know the statistics of how many munis go to maturity vs getting called in 10 years?

Thank you for all you do to educate your reader!

I responded to the latter:

http://funds.eatonvance.com/Municipal-Bond-Fund-II-EIV.php

With CEFs, I look at the fund’s website, which I note above. This funds has a lot interest rate sensitivity, and a lot of oddball credits, many of which are insured to AA. Remember that many guarantors failed in the last crisis. The question is economic necessity of existence for each creditor, which would take a lot more work to determine.

I don’t have any data on calls, but given the falling rate environment, most healthy credits that could call, did call. It would be stupid not to call.

But with respect to the former:

You can get the basic data on BTT here:

https://www2.blackrock.com/webcore/litService/search/getDocument.seam?contentId=1111182509&Venue=PUB_IND&Source=WSOD

The levered fund duration is astounding at 17.5 years.  A 30-year Treasury does not have that level of interest rate sensitivity.  The question to you is what is your time horizon?  Can you buy and hold, and if you do, will inflation and defaults eat you up?

I am not inclined to buy either EIV or BTT.  Municipal finance is not what it used to be, and players should recognize the weakened position of municipal borrowers.  The rating agencies are looking through the rear-view mirror to rate munis.

No, things are not as bad as Meredith Whitney posited, but they are bad, and the understatement of employee benefit liabilities are significant.

On tender option bonds, you have it basically right, and there is not much more to it than what you said, but here is the full treatment from Nuveen.

Here’s the trouble with muni bond portfolios: to get a great yield you have to take a lot of the following risks:

  • Liquidity
  • Credit
  • Guarantor
  • Leverage
  • Duration

These are not trivial risks, and so I am unlikely to invest in high yielding municipal bond Closed End Funds.

By David Merkel, CFA of alephblog.com

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David J. Merkel, CFA, FSA — 2010-present, I am working on setting up my own equity asset management shop, tentatively called Aleph Investments. It is possible that I might do a joint venture with someone else if we can do more together than separately. From 2008-2010, I was the Chief Economist and Director of Research of Finacorp Securities. I did a many things for Finacorp, mainly research and analysis on a wide variety of fixed income and equity securities, and trading strategies. Until 2007, I was a senior investment analyst at Hovde Capital, responsible for analysis and valuation of investment opportunities for the FIP funds, particularly of companies in the insurance industry. I also managed the internal profit sharing and charitable endowment monies of the firm. From 2003-2007, I was a leading commentator at the investment website RealMoney.com. Back in 2003, after several years of correspondence, James Cramer invited me to write for the site, and I wrote for RealMoney on equity and bond portfolio management, macroeconomics, derivatives, quantitative strategies, insurance issues, corporate governance, etc. My specialty is looking at the interlinkages in the markets in order to understand individual markets better. I no longer contribute to RealMoney; I scaled it back because my work duties have gotten larger, and I began this blog to develop a distinct voice with a wider distribution. After three-plus year of operation, I believe I have achieved that. Prior to joining Hovde in 2003, I managed corporate bonds for Dwight Asset Management. In 1998, I joined the Mount Washington Investment Group as the Mortgage Bond and Asset Liability manager after working with Provident Mutual, AIG and Pacific Standard Life. My background as a life actuary has given me a different perspective on investing. How do you earn money without taking undue risk? How do you convey ideas about investing while showing a proper level of uncertainty on the likelihood of success? How do the various markets fit together, telling us us a broader story than any single piece? These are the themes that I will deal with in this blog. I hold bachelor’s and master’s degrees from Johns Hopkins University. In my spare time, I take care of our eight children with my wonderful wife Ruth.

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