Recently Nuveen announced it will change the way 16 of its Municipal Bond funds leverage their holdings by partially replacing Auction Rate Preferreds (ARPs) with MuniFund Term Preferred (MTPs). They are likely to continue this trend across all of their municipal bond funds, at least until a more viable structure can be developed. Replacing floating rate leverage with 5 year fixed costs may hinder their ability for future dividend increases, however it will give more stability to their funds dividends when short rates rise and the effects of ARP penalty rates are measured in full percentage points.
According to Nuveen:
MTP is a fixed rate form of preferred stock with a mandatory redemption period of five years. By issuing MTP, the funds seek to take advantage of the current historically low interest rate environment to lock in an attractive taxexempt cost of leverage for a period as long as the term of the MTP. Issuing MTP helps the funds mitigate the risk of a significant increase in their leverage costs should short-term interest rates rise.
NVG & VKQ
Two CEFs that illustrate the different leverage funding structures are NVG - Nuveen Insured Dividend Advantage Municipal Fund which redeemed a portfion of its ARPs with 5 year MTPs, and VKQ - Van Kampen Muni Trust which levers using ARPs and tender option bonds. Currently NVG and VKQ yield 5.98% and 7.25% respectively. With the risk of interest rates rising, the extra yield in VKQ may expose investors to greater share price volatility as its leverage funding costs are likely to rise potentially compressing future distributions. Investors looking for municipal bond income should consider the effects of the type of structural leverage being utilized.
Disclosure: No positions