Weekly Review: Municipal Bond CEFs - A Steep Downturn In The Sector

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Includes: AKP, BHV, BZM, EIA, EIM, EIV, EVN, EVY, IIM, MPA, MUB, NAC, NAD, NEV, NHA, NIQ, NKG, NMS, NMT, NMZ, NNC, NPN, NPV, NQP, NUO, NYH, OIA, TLT, VCF, VKI, VKQ, VTN
by: Arbitrage Trader

Summary

Review of where municipal closed-end funds and their benchmark ended the week.

Comparison of the yields and Municipal/Treasury spread ratio.

Recap of news related to the sector.

Comparison among the funds using several important metrics.

Introduction

Over the past few months, most of you have noticed our increased activity in closed-end funds as the inflow of volatility finally shook them up and created various arbitrage, and directional, opportunities for active traders like us.

Now that these products have grabbed our attention, we are continuously monitoring most funds by sector and will reinstate our Weekly Review, publishing a recap of the groups of interest.

The Benchmark

It was a tough week for the municipal bond CEFs. The main index, the iShares National AMT-Free Muni Bond ETF (NYSEARCA:MUB), fell by $0.69 on a weekly basis. We should take into consideration the fact that the benchmark paid a dividend of $0.23, but even so, the recent decline is significant.

Source: Barchart.com - iShares National AMT-Free Muni Bond ETF

As you know, we follow the performance of the U.S. Treasury bonds - considering them the risk-free product - with maturities greater than 20 years: the iShares 20+ Year Treasury Bond ETF (NYSEARCA:TLT). The reason for that is the strong correlation between these major indices, and the chart below proves it. Additionally, a statistical comparison is provided by our database software:

Source: Barchart.com - iShares 20+ Year Treasury Bond ETF

Source: Author's software

Comparison Of The Yields And Municipal/Treasury Spread Ratio

Investing in municipal bonds is popular because they have the potential to offer higher yields than similar taxable bonds. If an investor wants to know whether muni bonds are cheap in comparison to taxable bonds or Treasuries, they could find out by comparing them. However, this method does have its limitations, and the investor should perform a more thorough analysis before making a decision:

Source: Bloomberg.com, Municipal and Treasury Yields

Source: Bloomberg.com, Municipal and Treasury Yields

The Municipal/Treasury spread ratio, or M/T ratio as it is more commonly known, is a comparison of the current yield of municipal bonds to U.S. Treasuries. It aims to ascertain whether or not municipal bonds are an attractive buy in comparison. Essentially, an M/T ratio north of 1 means that investors receive the tax benefit of muni bonds for free, making them even more attractive for high net worth investors with higher tax rate considerations.

Source: Bloomberg.com, Municipal and Treasury Yields

The narrowing spread and 3-months LIBOR are important for the leveraged municipal funds, and they can be highly affected by them. The 3-months LIBOR rate is a commonly used funding benchmark for the municipal bond CEFs.

Source: YCharts.com, 10-2 Year Treasury Yield Spread and 3-Month LIBOR based on US Dollar

Weekly Charts

1. Funds traded at discount and Z-score less than -1.40 points

Source: CEFConnect.com

2. Funds traded at discount and yield on NAV above 5%

Source: CEFConnect.com

The News

Source: Yahoo News, Municipal Bond Closed-End Funds News

Over the past week, the most important events were around the dividend cuts in the sector. I will keep the focus only on these funds which decreased their distributions.

Sponsor Fund Ticker Change from the prior distribution
Invesco Advantage Municipal Income Trust II (VKI) -$0.0024
Invesco Invesco Municipal Income Opportunities Trust (OIA) -$0.0016
Invesco Invesco Municipal Trust (VKQ) -$0.0038
Invesco Invesco Trust For Investment Grade New York Municipals (VTN) -$0.0029
Invesco Invesco Value Municipal Income Trust (IIM) -$0.0026
Nuveen Nuveen Municipal High Income Opportunity Fund (NMZ) -$0.0035
Nuveen Nuveen Enhanced Municipal Value Fund (NEV) -$0.0055
Nuveen Nuveen Intermediate Duration Quality Muni (NIQ) -$0.0035
Nuveen Nuveen Municipal 2021 Target Term Fund (NHA)

-$0.0015

Nuveen Nuveen Quality Municipal Income Fund (NAD)

-$0.0040

Nuveen Nuveen California Quality Municipal Income Fund (NAC)

-$0.0045

Nuveen Nuveen Georgia Dividend Advantage Municipal Funds 2 (NKG)

-$0.0035

Nuveen Nuveen Massachusetts Premium Income Municipal Fund (NMT)

-$0.0035

Nuveen Nuveen Minnesota Muni Income (NMS)

-$0.0040

Nuveen Nuveen North Carolina Premium Income Municipal Fund (NNC)

-$0.0030

Nuveen Nuveen Ohio Quality Income Municipal Fund (NUO)

-$0.0030

Nuveen Nuveen Pennsylvania Investment Quality Municipal Fund (NQP)

-$0.0035

Nuveen Nuveen Pennsylvania Municipal Value Fund (NPN)

-$0.0025

Nuveen Nuveen Virginia Premium Income Municipal Fund (NPV)

-$0.0025

Delaware Delaware Investments Colorado Municipal Income Fund (VCF)

-$0.0050

Eaton Vance Eaton Vance Municipal Income Trust (EVN)

-$0.0067

Eaton Vance Eaton Vance New York Municipal Income Trust (EVY)

-$0.0067

Eaton Vance Eaton Vance California Municipal Bond Fund II (EIA)

-$0.0042

Eaton Vance Eaton Vance Municipal Bond Fund (EIM)

-$0.0033

Eaton Vance Eaton Vance Municipal Bond Fund II (EIV)

-$0.0033

Eaton Vance Eaton Vance New York Municipal Bond Fund II (NYH)

-$0.0042

Review Of Municipal Bond CEFs

1. Lowest Z-Score

Source: CEFConnect.com

Our weekly review is starting with the closed-end funds sorted by their lowest Z-score. The main aim here is to show us which of the funds are statistically undervalued at the moment. Ideally, to find a reasonable "Long" candidate, we would like to have a statistical edge accompanied by a discount of more than 10%. As an active trader, I pay attention to the average daily volume, as well.

For a third consequent week, the BlackRock MuniYield Pennsylvania Quality Fund (NYSE:MPA) is leading the table with its Z-score of -2.40 points. Furthermore, its spread between price and net asset value is 14.71%, and probably it will not be time wasting if you decide to review the fund as a potential candidate for your portfolio.

Source: CEFConnect.com, BlackRock MuniYield Pennsylvania Quality Fund

The average 1-year Z-score in the sector is -0.33 point. The last time, the average Z-score of the municipal sector was -0.39 point.

Source: CEFConnect.com

2. Highest Z-Score

Source: CEFConnect.com

On the other hand, I am sorting the table by the highest Z-score in order to understand if there is a fund which could be a potential "Sell" candidate or at least a hedging reaction of some of our "Long" positions. Еxcept for PIMCO funds, we have several participants with a satisfying Z-score. Unfortunately, they are still traded at a discount and they do not meet my criteria to review them as potential "Short" candidates. I am following the performance of the Alliance California Municipal Income Fund (NYSE:AKP) and the BlackRock Maryland Municipal Bond Trust (NYSEMKT:BZM). If we see a shift from a discount to a premium, then I will review them.

3. Biggest Discount

Source: CEFConnect.com

The average discount/premium of the sector is -8.15%. The above table shows potential "Buys" with a discount of more than 14%, and most of them have the statistical edge that I am looking for. If you are planning to expand your portfolio with "Long" positions, these criteria are a strong foundation to start with.

Source: CEFConnect.com

4. Highest Premium

Source: CEFConnect.com

In the above table are the funds which are trading above their net asset values. Theoretically, the participants should be reviewed as potential "Sell" candidates, but we know the willingness of the market participants to pay a premium for the PIMCO funds. Except for their representatives, we have two more closed-end funds which I am going to comment on.

Definitely, the BlackRock Virginia Municipal Bond Trust (NYSEMKT:BHV) does not meet my requirements. It has only 3,000 shares average daily volume.

The Invesco Municipal Income Opportunities Trust (OIA) seems like a reasonable "Sell" candidate. The fund is traded at 7.33% premium, and its Z-score indicates for a statistical edge. Another important factor is the dividend cut which was announced. The regular monthly distribution will be decreased by -$0.0016 per common share.

Source: CEFConnect.com, Invesco Municipal Income Opportunities Trust

Source: CEFConnect.com, Invesco Municipal Income Opportunities Trust

5. Highest 5-year Annualized Return On NAV

Source: CEFConnect.com

The above sample shows the funds with the highest return on net asset value for the past five years. The average return for the past five years is 7.07%.

The Eaton Vance Municipal Income Trust (EVN) is again taking the first position, and it is even increasing its return on a weekly basis to 12.39%.

6. Highest Distribution Rate

Source: CEFConnect.com

The table shows the funds with the highest distribution rate on price. Additionally, I have included here the distribution rate based on net asset value. Most of the market participants find the second metric to be more important. The average yield on price is 4.72%, and the average yield on net asset value is 4.35%.

Below on the chart, I plotted the yields of funds from the sector with a discount of more than 10% and a Z-score less than -1.20 points.

Source: CEFConnect.com

7. Lowest Effective Leverage %

Source: CEFConnect.com

From a leverage perspective, we have six closed-end funds whose effective leverage is equal to zero. The average effective leverage of the sector is 35.6%. Do not underestimate the effect of the leverage, and be sure it is included in your analysis.

Conclusion

It was a tough week for the municipal bond CEFs and for the fixed-income instruments. The renewed bets on a stronger economy and higher inflation could affect the prices in the sector. Definitely, the change in interest rates will play a role. Compared to the previous year, the discounts of closed-end funds holding such products have significantly widened. While I find this to be fundamentally justified, I always expect some buying impulse to give us at least a mean-reversion trade in these products.

Note: This article was originally published for our subscribers on 9/09/2018, and some figures and charts may not be entirely up to date.

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in NBH over the next 72 hours.

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.