BBN: Getting Too Cheap To Ignore

Summary

  • Municipal debt continues to be well supported by few defaults and a strong credit backdrop for IG debt.
  • BBN continues to have an above-average amount of interest rate risk. This makes me reluctant to get too bullish, but the current price has baked in some of this risk.
  • The fund is sitting with a discount to NAV nearing 6%. That has historically been a level where buyers make a nice profit on this product.
  • This idea was discussed in more depth with members of my private investing community, CEF/ETF Income Laboratory. Learn More »

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Main Thesis/Background

The purpose of this article is to evaluate the BlackRock Taxable Municipal Bond Trust (NYSE:BBN) as an investment option. This fund offers exposure in taxable municipal bonds, with an objective to "seek high current income, with a secondary objective of capital appreciation." This is a fund I cover regularly and cautioned against buying at the end of last year. In hindsight, I was right not to recommend this fund, but I should have been more bearish than neutral on it. The reason being BBN has dropped 18%, far outpacing the broader market declines we have seen this year:

Fund Performance

Fund Performance (Seeking Alpha)

As we push deeper into 2022, I felt it was timely to take another look at BBN to see if I should buy now. While I have not been a big proponent of this fund recently, the drop has put it almost in bear market territory. This generally warrants at least another look, if not an outright buy.

After review, I do see some reasons to get long here. The fund's discount to NAV is very attractive. While the slide in the market price has been painful, it reminds followers that the underlying value has held up better. This makes for a relative value play. Further, municipal debt continues to benefit from a broad economic recovery and federal support to cities and states. Defaults remain rare, and I don't see that backdrop changing. While the leveraged nature of BBN is also a key risk, especially with the ongoing geo-political crisis in Europe, I see enough upside potential to warrant taking a stab at this fund.

2022 Has Been Hard On This Fund - What Gives?

To begin, I want to take stock of recent performance. Clearly, this has not been a good year for BBN thus far. As I noted above, the fund is almost in bear market territory. Of course, the drop isn't as bad as it seems when we consider the high distribution rate it pays, but it has registered short-term losses for investors nonetheless, as shown below:

YTD Performance

YTD Performance (Seeking Alpha)

I think this merits at least a recognition of the why behind why this is happening, so readers can better evaluate whether this CEF is really for them. After all, many of the positive points regarding munis were the same three months ago as they are today, and that has not stopped the horrible price action we see above.

So, with that in mind, why has BBN been falling so hard? A key point is duration, which is very high for this particular fund. With interest rates set to rise in 2022, investors began to shed longer duration products. These are more interest rate sensitive, and therefore fall more when rates rise. BBN, with a duration above 13 years, falls directly in to this category:

Duration

Duration (BlackRock)

This matters because inflation has not been transitory, as many policy officials predicted (and hoped for) in 2021. While there were signals suggesting price pressures might ease in the new year, that has proven to not be the case as well. In short, inflation has beaten expectations, prompting market participants to become more hawkish in their rate hike outlook:

CPI

CPI (JPMorgan Chase)

As you can see, the CPI index is at a high level historically, and has been accelerating even as 2022 has gone on. As a result, BBN became quickly out of favor, which is a trend that continues to this day (The fund is down another 1% at time of writing on 3/15).

Another reason BBN has suffered so disproportionately is that it uses a large amount of leverage, at almost 35% fund assets:

Leverage

Leverage (BlackRock)

The result from this has been two-fold. When a sector/theme/idea falls out of favor, a leveraged play on it is going to perform even worse. This is the inherent risk of leverage - in good times you out-perform, in bad times you under-perform. Aside from amplified returns, investors started to shed leverage because they are concerned rising interest rates will force up borrowing costs. This is true, and will ultimately mean funds like BBN, and any other leveraged product, will have to pay more to borrow and use that leverage. Of course, some of this should be balanced out because as rates go up, the yield offered by the securities BBN will put in its portfolio should also increase. But that will take some time to adjust, while borrowing costs will rise right away.

In summary, these risks were discussed going in to 2022, and they turned out to do exactly what I was concerned would happen. BBN has taken a big hit, and the problem is that these issues remain relevant today. I use this to manage expectations. While I do see a path higher for BBN, and I will discuss why in the paragraphs that follow, this is by no means a sure thing. The broader forces at work (rising inflation, fear of leverage) are still relevant today, and they could very well pressure the fund further in the weeks to come.

Why Buy Now? Valuation Is Cheap

There are a few reasons why I like BBN at these levels, and a primary one of them is valuation. Back in 2021, this fund was trading at a premium price, often much higher than its normal trading range. While this valuation came down a bit by the end of December, BBN still sat with a premium to NAV over 1%. I was reluctant to recommend the fund at that level and, clearly, that was an appropriate thesis.

The fortunate news for investors today is this dynamic has shifted considerably. While BBN has seen its NAV fall, it has fallen by a smaller amount than the market price. As a result, BBN is trading at a discount to NAV at almost 6%. With the fund dropping today (3/15), that 6% level has probably been breached:

Fund Facts

Fund Facts (BlackRock)

The takeaway here is simple. Buying this fund at a discount has worked out advantageously in years past, and I see a similar environment for this to happen again today. Again, this does not guarantee any type of positive return. But buying here does reward investors for their patience, and it is at a level where I absolutely feel comfortable putting cash to work.

What About Interest Rate Risk?

The next point touches on the interest rate risk component. This, in fairness, is a fundamental reason behind my reluctance to recommend BBN in 2021. So, what has changed?

Not a lot as of right now, but I think we are finally getting to the point where inflation may ease a bit and this is being coupled by more dovish central banks. The logic behind this statement is that inflation metrics are being driven heavily by energy costs (reference the prior CPI graphic). With oil and gas spiking due to the Russia-Ukraine conflict, it seemed inflation was only going to get worse. However, futures markets are starting to predict the worst has passed. Oil prices have come down measurably in the past week:

Energy Prices

Bloomberg

While this may not be sustainable, a resolution in Ukraine, or even assurance that the conflict will not expand in to NATO territory, is sure to keep energy prices from re-testing prior highs. Further, the rise in prices has been encouraging more domestic production. This means additional supply could be hitting the markets soon (although we still have a long way to go):

Number of Active Oil Rigs

Number of Active Oil Rigs (Yahoo Finance)

My point here is that as oil prices fall, a major contributor to inflation is easing. This bodes well for high duration funds like BBN, because it should keep yields from rising too aggressively.

Compounding this, is that central banks have become more dovish in the face of the Russian invasion. Traders had anticipated a .50 basis point move from the Fed when they meet this week, but the uncertainty caused by that crisis have forced them to back off from getting too aggressive. While we will have more clarity shortly, Fed Chairman Powell recently stated:

Fed Expectations

Fed Expectations (USA Today)

From this, I can conclude that income-generating securities could get a bit of a boost, as the Fed has made a recent shift in their favor.

Ultimately, this is an important point because a major headwind for BBN - rising inflation and rising yields/rates - has cooled somewhat. While macro-developments like this can change quickly, I see support for the fund in the near term.

California Debt Looks Well Supported

I will now take a look at the underlying holdings for BBN. One attribute that stands out is that this fund is heavily allocated to Californian debt. At almost 1/5 of total fund assets, the outlook for California munis is very relevant:

State Weightings

State Weightings (BlackRock)

This good news here is that I view this positively for the fund. The inclusion of California muni bonds is helpful because the state is facing a stronger financial picture than it did in coming out of the pandemic. California in particular has done quite well, as the state has a large number of wealth residents. These residents face high tax rates in the state, but have disproportionately benefited from a rising stock market and the appreciation of other real assets (like housing, commercial real estate, commodities, etc.). Resulting from this dynamic has been a boost to California's coffers, as capital gains among residents hit levels in 2020 and 2021 that were vastly higher than prior years:

California rich driving state revenue

Cali's Rich Driving State Revenue (Bloomberg)

I find this very relevant for BBN because it is heavily tied to the fortunes of the Golden State. Seeing more revenue and income come into state coffers boosts the credit quality of the underlying assets. This increases the likelihood the state will continue to make good on its obligations, and also that investors are going to be willing to buy up these bonds.

The Flight Out Of Munis Is A Rare Occurrence

My final point looks at the broader muni picture. This is relevant for BBN, and for any other muni fund readers are using to invest in this space. Historically, this has been a strong asset class in terms of generating an attractive income stream, and also in providing a bit of a hedge against equity drops. Generally, fund flows in to this sector as positive, especially at the beginning of the year when tax preparation is top of mind. However, in 2022, fund flows have been consistently negative, reversing a trend we have seen over the past year.

My takeaway on this is it will be temporary. I expect munis more broadly to catch a bid as time goes on. It is an asset class many investors tend to buy and hold, and is also a way that financial institutions are able to build up their short-term, liquid asset base. While the headwinds facing the sector, and BBN by extension, are not going to evaporate overnight, I see the generally flee from this sector as an opportunity. It makes sense to buy what is out of style, as long as the longer term picture is sound. For munis, I believe it is, and see the current weakness as a chance to gain off the losses of others.

Bottom-line

BBN has been a bucket of pain in 2022. To me, this signals it is time to buy, although I can understand why current investors may be a bit shell-shocked. But for new capital, the buy-in here seems very reasonable. Energy prices are starting to ease, which could help bring down the runaway inflation we are seeing. BBN's valuation is very attractive, and its income stream will remain competitive even as the Fed begins a modest rate hiking cycle. As a result, I have begun to dive back into BBN, and suggest readers give this fund some consideration at this time.

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This article was written by

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CEF/ETF income and arbitrage strategies, 8%+ portfolio yields

Macro-focused investor, working for a major U.S. bank. I grew up in New York, but escaped to North Carolina. I was a D1 athlete in college (men's tennis) and compete competitively to this day. My Bachelor's and MBA are both in Finance.

I provide reasoned, fact-based analysis of different funds and sectors. I list my portfolio here so readers can gain insight into what I am buying/holding, what I'm not, and how that lines up with the views I present in my articles. 

Broad market: VOO; QQQ; DIA, RSP

Sectors: VPU / BUI; VDE / UCO; KBWB; XRT

Non-US: EWC; EWU; EIRL; EWA

Dividends: DGRO; SDY, SCHD

Municipals/Debt Funds: NEA, BBN, PDO, BGT

Stocks: WMT, JPM, MAA, SWBI, MCD, DG, WM

Cash position: 25%

Disclosure: I/we have a beneficial long position in the shares of BBN either through stock ownership, options, or other derivatives. 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.

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