Seeking Alpha
Value, special situations, debt
Profile| Send Message|
( followers)  
This is one of a series of articles on municipal bond closed-end funds. For this report I’ve selected the Invesco Municipal Premium Income Trust (PIA).
PIA is a leveraged fund that seeks high income exempt from federal income tax with investment grade municipal bonds. PIA is currently a good muni bond CEF to monitor for an investor subject to the alternative minimum tax (AMT). But recently, PIA has been under-earning its dividend payouts. It may pay to wait for a dividend reduction first and then buy PIA on weakness.
I will be discussing 14 factors you can consider when evaluating any municipal bond closed-end fund. For more background information on these factors, refer to my first report on Nuveen (NPM). I still like NPM, which has recovered nicely since the big Whitney-induced “bottom” back in January. NPM recently reported that as of May 31, the percentage of Florida bonds in the portfolio had fallen to 27.75%, down from 31.28% at year end. This ratio should continue to drop gradually over the next few years.
Factor #1: What is the distribution rate?
In the current market, there are three “tiers” of national muni bond closed-end funds. The higher risk leveraged funds have distribution rates around 8%. The middle tier lower risk leveraged funds yield around 7%, and the safer, low volatility funds, which are mainly unleveraged, yield in the 5% range.
PIA is a high quality fund in the middle tier and currently has a distribution yield of 7.04%. It pays a regular monthly dividend of $0.045 per share or an annual distribution of $0.54.
Factor #2: What is the likelihood the fund can raise its monthly dividend?
To determine this, I look at the Average Earnings/Current Dividend Ratio. This ratio tells you whether or not a fund is earning its current dividend. If the value is well above 100%, it means the fund can easily afford to raise its distribution rate.
For PIA, the average earnings over the last three months ending April 30 is $0.0408, so the Average Earnings/Current Dividend ratio= 90.7%. I consider this an unfavorable factor for PIA, since it is has not been earning its dividend and may have to cut it soon.
I like to see a positive value for “Undistributed Net Investment Income” or UNII. This is the life-to-date balance of a fund’s net investment income less distributions. For PIA, the UNII per share is +0.085 which is still positive, but has been steadily dropping. These are the UNII balances reported for the last few months:
12/2010 0.106
01/2011 0.103
02/2011 0.097
03/2011 0.090
04/2011 0.085
Factor #3: What is the Expense Ratio?
I look at the baseline expense ratio which does not include leverage costs. PIA has a baseline expense ratio of 1.02% which is about average.
Factor #4: What is the discount to NAV?
PIA is currently selling at a 5.77% discount to NAV, which is slightly more than the six-month average discount of 4.99%. The one-year Z statistic is -0.89, or nearly one standard deviation below average. Overall, this factor is a positive for PIA.
Factor #5: How much leverage is used, and what is the preferred share asset coverage?
In 2008, some leveraged closed-end funds got into trouble because they violated the Investment Company 1940 Act when their asset coverage for the preferred shares went below 200% and they were forced to liquidate portions of the fund at a bad time. PIA currently uses 42.55% leverage. The preferred asset coverage ratio is currently 340% which provides a large margin of safety.
Factor #6: What is the AMT exposure?
PIA has an AMT percentage of only 0.03%. This is a strong positive factor for PIA for investors who are subject to the AMT. I consider 10% AMT to be about average, and anything over 20% is high.
Factor #7: What is the credit quality?
I look at the breakdown of AAA, AA, A, BBB, Below BBB & Unrated. Within the AAA category, a higher percentage of pre-refunded bonds is a positive, because these bonds are effectively backed by the US government.
This is the ratings breakdown for PIA:
AAA
4.06%
Pre-refunded
AA
47.07%
A
23.88%
BBB
21.19%
BB & Below
3.78%
Includes unrated.
PIA is a solid fund with an average credit rating around AA-. I like to see the lowest rating category below 10%, and PIA qualifies easily.
Factor #8: What is the interest rate exposure?
PIA has an average effective duration of 11.29. This is a bit on the high side, and I would prefer a lower duration below 10.0. But PIA can be combined with other lower duration funds in order to reduce interest rate volatility risk to a more acceptable level as needed.
Factor #9: What is the call exposure?
Owning a callable bond is similar to owning a stock and writing a covered call against it. But with the callable bond, the option is embedded instead of external. The call option is owned by the issuer, and can have the effect of taking away some of your upside potential if interest rates decline significantly.
Here is a table with the call dates for bonds in PIA:
Non callable
17.16%
2011
7.00%
2012
5.29%
2013
6.60%
2014
15.91%
2015-2021
48.04%
PIA has limited call risk over the next few years. It has an average bond price of 100.3. I am not so concerned about the falling interest rate scenario, since PIA will be highly profitable if this occurs.
Factor #10: For a national fund, what is the breakdown by state?
Here is a breakdown by state for the PIA portfolio (top 5):
New York
13.75%
Florida
12.37%
California
10.56%
Texas
7.59%
Illinois
7.56%
When you first look at this table, a red flag goes up because of the high concentration of bonds from Florida. But there is a good explanation for this. NPM recently acquired two other Florida closed-end funds.
One state I look closely at is Illinois. I do not like to see the Illinois percentage exceed 10%, unless these bonds are very highly rated (AA or better) and for critical services like the water supply for Chicago. The Illinois percentage for PIA is below 10%.
Factor #11: How good is the trading liquidity?
PIA has an average daily volume of 34,000 shares and an average dollar volume of $0.26 million. PIA has somewhat limited liquidity and must be purchased with care if you're buying more than 1,000 shares.
Factor #12: What percent of the portfolio is in housing bonds?
Given the shaky housing market, I like to avoid funds where the housing sector (e.g. single family, multi-family) is above 10%. PIA has only 1.1% invested in housing sector bonds.
Factor #13: Fund Management
PIA is team-managed by Tom Byron, Robert Stryker, CFA and Robert Wimmel, who came to Invesco from Van Kampen (VIN).
Factor #14: Other Analyst Coverage
I am not aware of any Wall Street analysts who cover PIA.
Based on the above 14 factors, I believe that PIA is a good fund to monitor for investors subject to the AMT. But recently the fund has not been earning its dividend payouts. This may be because the fund has started using tender option bonds for leverage, in addition to auction rate preferreds. I would wait for PIA to reduce its dividend before buying it, unless the current trend reverses and it starts out-earning its dividend payout again.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
Source: Invesco Municipal Premium Income Trust: A Good Muni Closed-End Bond Fund