Mid-Year Review Of The Muni Bond CEF Landscape

 |  Includes: IQN
by: George Spritzer, CFA

While total net assets have increased, there has been some consolidation and the number of municipal bond closed-end funds has decreased over the last six months. Here is a breakdown using the cefconnect screener as of today:

Muni Bond CEF Counts

National muni funds: 101

Single State funds: 131

High Yield muni funds: 7

Build America Bond funds: 4 (taxable)


Total: 243

Additions: There has only been one new issue this year- MainStay Defined Term Muni Opportunity Fund (NYSE:MMD). This fund has about $486 million is assets. It currently trades at a 6% premium to NAV.

Fund Terminations: Three small Blackrock funds were liquidated this year: RFA, RNJ, RNY.

Fund Mergers/Consolidations

A large number of muni bond CEFs are being consolidated this year at Nuveen and Invesco. Once all of these consolidations are completed, the total number of muni bond CEFs will decrease to around 207.

Nuveen Single state Muni Fund CEF Mergers Already Completed

California- (NPC, NCL, NKL) merged into NKX.

Connecticut- (NFC, NGK, NGO) merged into NTC.

North Carolina- (NRB, NII, NNO) merged into NNC

Georgia- (NPG, NZX) merged into NKG.

Nuveen Muni CEF Mergers Expected Later This Year

Maryland- (NFM, NZR, NWI) merging into NMY

Virginia- (NGB, NNB) merging into NPV

Arizona- (NFZ, NKR, NXE) merging into NAZ

Michigan- (NMP, NZW) merging into NUM

Ohio- (NXI, NBJ, NVJ) merging into NUO

New York- (NUN, NNF, NQN, NVN, NKO) merging into NXK

National- (NIF, NPX) merging into NEA

Invesco Muni CEF Mergers Expected Later This Year

High Yield: MSY merging into VLT

National Value: (IMC, IMS, IMT) merging into IIM

National Income: (OIB, OIC) merging into OIA

California: (IIC, IQC, ICS) merging into VCV

National: (PIA, VIM, VKL) merging into VMO

New York: (IQN) merging into VTN

Miscellaneous: (VMV, VOQ, VTJ) merging into VKQ

These fund mergers generally help long term shareholders since there should be cost savings which help reduce the fund expense ratio. When the mergers occur, the number of shares received of the surviving fund is based on the ratio of the net asset value in each acquired fund after UNII distributions are paid out.

There can be trading opportunities to purchase a less expensive fund and pick up some "alpha" when it converts into a more expensive fund. But most of these funds are highly illiquid, so the bid-asked spread and other trading costs need to be taken into account.

Municipal Bond Default Risk

There have been some recent scary headlines about potential municipal bankruptcies in San Bernardino and Stockton, California. While these situations should be closely followed, there have only been eight Chapter 9 bankruptcy filings this year, totaling about $1 billion in outstanding par value. This represents a miniscule 0.03% of total municipal bonds outstanding.

To put things in perspective, there were eleven muni Chapter 9 bankruptcy filings in 2011 and six filings in 2010. Compare this to the over 10,000 corporate Chapter 11 bankruptcy filings which occur every year.

One advantage of municipal bond CEFs is that they are actively managed and almost always avoid these Chapter 9 bankruptcy situations. So far this year, muni bond CEFs have performed very well and many have been making 52 week highs. The few muni defaults have had virtually no impact on the NAVs or the fund's ability to pay distributions.

Muni Bond CEF Distributions

While muni defaults have not affected distributions this year, there are two other factors that have reduced earnings and distributions of some funds:

- Increased Bond Calls: The lower interest rate environment has led to an increased number of bond calls. The replacement bonds have lower coupons which affect the ability to maintain the dividend.

- Replacement of ARP Financing: Some funds have been pressured to replace their low cost ARP financing with other higher cost forms of leverage. This reduces earnings and the ability to pay dividends.

In spite of the above two factors, dividend reductions have been modest so far, since leverage costs have been low for quite some time, and many funds have built up a substantial "cushion" of UNII (undistributed net income). Even with the dividend cuts, muni CEFs are still quite attractive on a relative basis when compared to taxable bond or preferred stock CEFs which are also seeing increased call activity and reduced dividend payouts.

It is becoming more important to regularly check the call exposure of muni bond CEFs. You would ideally want to see a low call exposure for the next two years and a somewhat higher duration. One fund that scores well in this regard is NEV which has call exposure of only 3.7% in 2012 and 2.84% in 2013. Some investors have already noticed this, since NEV currently trades at a 5% premium.

Disclosure: I am long IQN, PIA.