Nuveen Build America Bond Fund: A Taxable Muni Bond Closed-End Fund That Pays You To Own It

| About: Nuveen Build (NBB)
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Summary

NBB: A closed-end fund with a termination date.

Discount to NAV guaranteed to narrow over time.

Underlying asset class is unpopular and not well understood.

Many closed-end fund traders try to exploit narrowing of a fund's discount to net asset value. This strategy often works well, but there are many cases where a discount can remain wide for long periods of time.

One example is the Adams Express fund-ADX, one of the oldest closed-end funds, which started trading in 1929. It has a low expense ratio, but still generally trades at around a 14% discount to net asset value, and this discount has remained for many years. ADX is a good fund, but there has not been a catalyst to narrow its discount to net asset value.

In other cases, a fund's discount may widen considerably before it eventually narrows. An example where this occurred was PDI, which I recommended several times last year. The fund's discount seemed attractive at -5%, but because of tax loss selling, the discount actually ballooned as high as -11% last summer.

PDI has since recovered and the discount is now only -1%. Longer-term investors have done fine. But some unfortunate investors may have panicked and sold out near the low point.

For investors who do not want to trade actively but still want to take advantage of CEF discounts, a good alternative is to look for closed-end funds with a termination date. When a term trust is liquidated, the discount to NAV is eliminated.

The Nuveen Build America Bond Fund (NYSE:NBB) is a term national CEF that primarily invests in high quality taxable municipal bond holdings issued as part of the Build America Bonds (or BAB) program. It has a termination date of June 30, 2020.

The BAB program began in April 2009. The interest income from BAB bonds is taxable at the Federal level, but a 35% tax benefit goes to the issuers who receive a subsidy from the federal government.

The BAB program ended on December 31, 2010. There is still a fairly large secondary market of issued BABs, but unless there is new legislation, no more new BABs will be issued. As existing bonds mature or are called, there may eventually develop an extra scarcity value for the existing BAB bonds.

What is the distribution rate?

NBB is a high quality fund and currently has a distribution yield of 7.19%. It currently pays a monthly dividend of $0.116 per share or an annual distribution of $1.392.

NBB pays taxable income, but it is a very good holding for an IRA, for those in lower tax brackets or for tax exempt investors like non-profit charities or foundations.

Why should the distribution rate be adjusted?

Because NBB is a term trust, it is guaranteed that the discount to net asset value will go zero at the termination date. Because of this, it is similar to buying an individual bond at a discount to par value. For individual bonds, when a yield is computed for a discount bond, the calculation includes the additional profits earned as the bond returns to par value.

Let's see how the calculations look for NBB using closing prices from March 14. The termination date is June 30, 2020 when the discount for NBB will go to zero. The calculation for Discount Drop per year is:

Discount Drop Per Year= Discount / (Years To Termination)

NBB Analysis

Price

19.36

Date

3/14/2014

Discount

9.00%

Termination Date

6/30/2020

Distribution Rate

7.19%

Years To Termination

6.30

Discount Drop per year

1.43%

Baseline Expenses

0.92%

Adj. Expense Ratio

-0.51%

Adj. Dist Rate

8.62%

Note that the discount drop per year of 1.43% is actually greater than the baseline expense ratio of 0.92%. So the adjusted expense ratio is negative and you effectively get paid 0.51% to own this professionally managed fund!

I also compute an adjusted distribution rate, which adds the discount drop per year to the original distribution rate. The adjusted distribution yield for NBB is an attractive 8.62% and this does not require any trading. You simply wait until the termination date and the discount automatically goes to zero.

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 NBB, the average earnings over the last three months is $0.1166, so the Average Earnings/Current Dividend ratio= 100.52%. NBB is basically earning its distribution, so in the short term it will probably maintain the current monthly payment rate.

There is a positive value for "Undistributed Net Investment Income" or UNII of +0.0276, which also provides a small buffer.

What is the fund turnover ratio?

Since there will be no new issuance of BAB bonds, I expect the turnover ratio for NBB to be quite low which should reduce trading expenses. The negative adjusted expense ratio and low turnover makes NBB quite attractive to a long-term investor.

What is the discount to NAV?

NBB is currently selling at a -9.00% discount to NAV, which is close to its one-year average discount of -8.94%. But as the termination date approaches, this discount is guaranteed to gradually approach zero.

How much leverage is used, and what is the preferred share asset coverage?

NBB currently uses 29.43% effective leverage. The preferred asset coverage ratio is currently 732%, which provides a large margin of safety. I would not be concerned unless this ratio dips below 225%. The average cost of leverage is 0.78%, which is very attractive.

What is the AMT exposure?

Since NBB is a taxable fund, this factor is not applicable.

What is the credit quality?

I look at the breakdown of AAA, AA, A, BBB, Below BBB & Unrated.

This is the ratings breakdown for NBB:

AAA

7.8%

AA

48.1%

A

32.7%

BBB

8.6%

BB & Below

2.8%

Includes unrated.

NBB is a very solid fund with an average credit rating around AA-. I like to see the lowest rating category below 10%, and NBB qualifies easily. NBB does not hold any pre-refunded bonds.

What is the interest rate exposure?

NPM has a leverage-adjusted effective duration of 12.33 years. This is above average, and I would prefer a somewhat lower duration below ten years. If the overall interest rate level rises by 1%, the price of NBB would fall by about 12%. But as the termination date approaches, the effective duration of NBB should gradually diminish reducing its interest rate exposure.

How good is the trading liquidity?

For the last three months, NBB has an average daily trading volume of 88,000 shares, and an average dollar volume of $1.7 million. You should be able to buy $50,000 of NBB in one day fairly easily without a major impact on the price.

Fund Management

NBB is co-managed by Daniel J. Close and John Miller. Daniel joined Nuveen in 2000 and has earned the CFA designation. He received his B.S. in Business from Miami University and his M.B.A. from Northwestern University's Kellogg School of Management.

John is Chief Investment Officer of Nuveen Asset Management and joined Nuveen in 1996 and has also earned the CFA designation. He has a B.A. in Economics and Political Science from Duke University, an MA in economics from Northwestern University and an MBA with honors in Finance from the University of Chicago.

Based on the above analysis, I believe that NBB is a good holding in an IRA or other tax deferred or tax exempt accounts. It may be especially attractive to a longer-term buy and hold investor who does not wish to follow the markets closely every day. Because of the termination date, the long-term investor is guaranteed to benefit from the narrowing of the discount to net asset value over time.

Disclosure: I am long NBB. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.