Investment firms such as Nuveen that offer leveraged Muni Closed End Funds have been suffering an inordinate amount of stress over the past few months. The auctions of preferred securities issued by the companys' municipal closed-end funds continues to fail; leaving most of the firms in a situation where they need to either forced to redeem their preferreds or make other financing arrangements.
Earlier HingeFire articles outlined the issues in the market (see Auction Rate Stress Continues: Muni Bond Funds Impacted and Revisiting: Muni Bond Fund shorts).
Nuveen has obtained a commitment of up to $1.75 Billion to refinance the struggling auction rate preferred securities. This enables the company issue variable-rate demand-preferred instruments to replace the current ARPS. This effectively alleviates the pain be endured by Nuveen and places the firm’s Closed End Fund (CEF) products back into a liquid situation. The company has also taken steps to remarket the new shares with another financial firm.
These measures are excellent news for the holders of the Nuveen muni CEFs – most whom are common investors looking for tax-free income with minimal risk.
Nuveen gets infusion for auction rate securities
Showing posts with label CEF. Show all posts
Showing posts with label CEF. Show all posts
Wednesday, May 21, 2008
Wednesday, March 19, 2008
Revisiting: Muni Bond Fund shorts
On February 20th, a HingeFire article urged investors to short several leveraged Muni Bond closed-end funds that hold significant amounts of low grade debt (see Auction Rate Stress Continues: Muni Bond Funds Impacted). These were viewed as low volatility, high probability short plays in the market. Three funds priced in the $13 to $14 range were pointed out as having a price downside of approximately a dollar over the upcoming weeks; MAF, VKQ, and VMO.
Now that a month has passed, let’s take a look at the results. The PIMCO Municipal Advantage Fund (MAF) dived from $13.14 on February 20th to close today at $12.17. The Van Kampen Muni Trust Fund (VKQ) was priced at $14.21 back in February and closed at $13.52 today. The Van Kampen Muni Opp Fund (VMO) crashed from $14.37 to close at $13.14 today. The average drop over the past month for these three funds was 96 cents (minus the six cents in dividends on average paid out during the period). – right on target as per the prediction for approximately a dollar gain for shorts over several weeks.
Now that a month has passed, let’s take a look at the results. The PIMCO Municipal Advantage Fund (MAF) dived from $13.14 on February 20th to close today at $12.17. The Van Kampen Muni Trust Fund (VKQ) was priced at $14.21 back in February and closed at $13.52 today. The Van Kampen Muni Opp Fund (VMO) crashed from $14.37 to close at $13.14 today. The average drop over the past month for these three funds was 96 cents (minus the six cents in dividends on average paid out during the period). – right on target as per the prediction for approximately a dollar gain for shorts over several weeks.
Friday, February 22, 2008
Bankrupt Cities, Muni failures, and CDS stress
Earlier commentary (see Will State SIV Funds bankrupt local communities?) discussed the stress that rising retirement costs, increasing payroll, and poor investments were placing on local governments. Recent headlines demonstrate this trend including the California city mulls filing for bankruptcy press and similar commentary from communities in Florida. ‘"As of April, we will not have the money to pay employees," Vallejo Councilwoman Stephanie Gomes said in a telephone interview. "It's just projected to get worse and worse.’ This situation is likely to become commonplace in 2008.
Many of these local governments have outstanding municipal bonds. In December the outlook for the muni bond market was discussed (see The Muni Bond dilemma). While a number of financial industry pundits claimed that the muni-bond sector would recover in 2008; the unfortunate reality is that the outlook over the upcoming months is bleak.
The failure in the past two weeks of the muni auction rate market simply underlines the calamity. Morgan Stanley announced the failure to auction the preferred shares for its closed end funds. Many other financial institutions were in a similar position this past week. This will all circle around as higher interest rates for communities as local governments are forced to pay default penalty rates on their muni bonds leading to further financial stress.
Adding to the credit concerns, Bill Gross of Pimco outlined this week that the CDS market is a huge systemic risk. "The conduits that hold CDS contracts are, in effect, non-regulated banks," says Mr Gross. "[There are] no requirements to hold reserves against a significant 'black swan' run that might break them." There is significant risk that counter parties will not be able to pay their obligations if the system breaks down, and the cracks are starting to show. The term “default shock” in now regularly used when discussing this $45 trillion market. ‘Credit default swaps are bigger than the US government bond and housing markets combined.’ Many skeptics view that this non-liquid market is primed for disaster as bond defaults approach historical means with minimum losses of $250 billion expected over the upcoming year.
The credit crisis has clearly spread beyond subprime; the contagion to muni-bonds, commercial CDS, and other sectors is not welcome news for investors. Systemic failure in any of these markets is likely to take down retirement plans and other major institutional holders leaving main street America effectively holding the bag. Investors should take a close look at their fixed rate investments and carefully evaluate their risk of structural failure. Common investments such as fixed rate annuities and other vehicles often hold CDS and other at risk instruments.
Similarly this is a time to cast a wary eye on the Muni Bond market despite the hype from firms that focus on selling these instruments. Investors should avoid pouring new money into muni bond funds or directly purchasing these bonds. Yield-focused investors should be concerned with the structural problems in the auction rate muni market, the failure of insurers, and local government fallout. These problems need to be resolved before the muni sector can be considered safe or viable.
Many of these local governments have outstanding municipal bonds. In December the outlook for the muni bond market was discussed (see The Muni Bond dilemma). While a number of financial industry pundits claimed that the muni-bond sector would recover in 2008; the unfortunate reality is that the outlook over the upcoming months is bleak.
The failure in the past two weeks of the muni auction rate market simply underlines the calamity. Morgan Stanley announced the failure to auction the preferred shares for its closed end funds. Many other financial institutions were in a similar position this past week. This will all circle around as higher interest rates for communities as local governments are forced to pay default penalty rates on their muni bonds leading to further financial stress.
Adding to the credit concerns, Bill Gross of Pimco outlined this week that the CDS market is a huge systemic risk. "The conduits that hold CDS contracts are, in effect, non-regulated banks," says Mr Gross. "[There are] no requirements to hold reserves against a significant 'black swan' run that might break them." There is significant risk that counter parties will not be able to pay their obligations if the system breaks down, and the cracks are starting to show. The term “default shock” in now regularly used when discussing this $45 trillion market. ‘Credit default swaps are bigger than the US government bond and housing markets combined.’ Many skeptics view that this non-liquid market is primed for disaster as bond defaults approach historical means with minimum losses of $250 billion expected over the upcoming year.
The credit crisis has clearly spread beyond subprime; the contagion to muni-bonds, commercial CDS, and other sectors is not welcome news for investors. Systemic failure in any of these markets is likely to take down retirement plans and other major institutional holders leaving main street America effectively holding the bag. Investors should take a close look at their fixed rate investments and carefully evaluate their risk of structural failure. Common investments such as fixed rate annuities and other vehicles often hold CDS and other at risk instruments.
Similarly this is a time to cast a wary eye on the Muni Bond market despite the hype from firms that focus on selling these instruments. Investors should avoid pouring new money into muni bond funds or directly purchasing these bonds. Yield-focused investors should be concerned with the structural problems in the auction rate muni market, the failure of insurers, and local government fallout. These problems need to be resolved before the muni sector can be considered safe or viable.
Wednesday, February 20, 2008
Auction Rate Stress Continues: Muni Bond Funds Impacted
As auctions continue to fail many municipalities are getting stuck with paying the default penalty rates. When no bidders emerge, the rates rise to very high levels for these securities which most issuers can not afford. This is likely to lead to a downward spiral of massive selling, a situation which would totally tank the industry.
Are local governments actually under such stress that projects are unlikely to fulfill their financial obligations? Clearly this frightening statement is the markets current take on the situation. The failure of the auctions is not really a reflection of the probable collapse of the bond insurance companies such as MBIA because some of the offerings are not insured. With both insured and uninsured muni bonds failing in the auction; this can only leave investors wondering if the systemic risk is increasing as the chaos continues. It appears that the pervasive fear has caused the collapse of all efficiency in the auction rate market.
A New York Times article points out the Closed End Muni Bond funds are the most impacted vehicle; all 102 auctions related to these securities failed on Tuesday. Despite having default penalty rates set to under 3.5%, the leveraged municipal bond funds will likely to be forced to redeem their preferreds, a situation that does not help the common or preferred shareholder.
This leads to some possible opportunities with leveraged Closed End Muni Bond Bunds. The ETF Connect site provides the capability to view the funds that utilize auction rate markets. Click on the auction rate tab on the right and select all tax-free funds in the screen. The results enable investors to review the recent winning rate and the day of the auction. Many of the rates above 3 percent demonstrate failed auctions with yields now set at the default rate.
Even more interesting is the potential of Muni funds with a large amount of BBB and below debt, whose auctions have not failed yet, to experience downside over the upcoming weeks. The PIMCO Municipal Advantage Fund (MAF) has over 30% assets in low graded bonds while the gap between the share price and NAV price has closed to the smallest discount in over a year. Any adverse event is likely to cause the price to drop despite the fund’s current 5.54% distribution rate.
Both the Van Kampen Muni Trust (VKQ) and Van Kampen Muni Opp (VMO) funds face a similar scenario. Both have over 20% of assets in low rated debt with a share price at the highest level relative to NAV in over a year. Upcoming auctions are likely to fail leaving these funds with potential downside despite their high distribution rates.
Unlike stocks, Closed-End Muni Bond funds don’t tend to move greatly in price. How much potential downside is available for shorts? On Wednesday and Thursday of last week, all of these funds have experienced large down days when the news of failing auctions spread throughout the market (see - More Credit Turmoil: The Muni Auction Rate market freezes). Most dropped 50 cents (4%) or more on an event that did not directly impact these particular funds at this point. As auctions fail on instruments offered directly by these funds, the fund prices should continue to drop. The question being – how much downside is left?
At minimum investors should expect the price to move back to the traditional statistical discount to NAV and then sink below this level. The price for these funds are likely to re-test two year lows as the fund managers struggle to redeem their preferred securities and are apt to reduce outgoing interest payments to the common share holders. The MAF fund is currently priced near $12.90 and the probable target price near a two year low is $12.00 with a likely yield rate rising near 6% after a price reduction. Most of these funds trade only 25,000 shares in volume each day on average, this however is enough liquidity to enable the creation of a short position. Investors will have to determine if the potential reward of approximately a dollar per share compared to the possible rebound risk makes it beneficial to short these securities over the upcoming weeks.
Disclosure: The author does not have a position in any of the equities mentioned in this article. The information provided does not constitute a solicitation to buy, or an offer to sell securities.
Are local governments actually under such stress that projects are unlikely to fulfill their financial obligations? Clearly this frightening statement is the markets current take on the situation. The failure of the auctions is not really a reflection of the probable collapse of the bond insurance companies such as MBIA because some of the offerings are not insured. With both insured and uninsured muni bonds failing in the auction; this can only leave investors wondering if the systemic risk is increasing as the chaos continues. It appears that the pervasive fear has caused the collapse of all efficiency in the auction rate market.
A New York Times article points out the Closed End Muni Bond funds are the most impacted vehicle; all 102 auctions related to these securities failed on Tuesday. Despite having default penalty rates set to under 3.5%, the leveraged municipal bond funds will likely to be forced to redeem their preferreds, a situation that does not help the common or preferred shareholder.
This leads to some possible opportunities with leveraged Closed End Muni Bond Bunds. The ETF Connect site provides the capability to view the funds that utilize auction rate markets. Click on the auction rate tab on the right and select all tax-free funds in the screen. The results enable investors to review the recent winning rate and the day of the auction. Many of the rates above 3 percent demonstrate failed auctions with yields now set at the default rate.
Even more interesting is the potential of Muni funds with a large amount of BBB and below debt, whose auctions have not failed yet, to experience downside over the upcoming weeks. The PIMCO Municipal Advantage Fund (MAF) has over 30% assets in low graded bonds while the gap between the share price and NAV price has closed to the smallest discount in over a year. Any adverse event is likely to cause the price to drop despite the fund’s current 5.54% distribution rate.
Both the Van Kampen Muni Trust (VKQ) and Van Kampen Muni Opp (VMO) funds face a similar scenario. Both have over 20% of assets in low rated debt with a share price at the highest level relative to NAV in over a year. Upcoming auctions are likely to fail leaving these funds with potential downside despite their high distribution rates.
Unlike stocks, Closed-End Muni Bond funds don’t tend to move greatly in price. How much potential downside is available for shorts? On Wednesday and Thursday of last week, all of these funds have experienced large down days when the news of failing auctions spread throughout the market (see - More Credit Turmoil: The Muni Auction Rate market freezes). Most dropped 50 cents (4%) or more on an event that did not directly impact these particular funds at this point. As auctions fail on instruments offered directly by these funds, the fund prices should continue to drop. The question being – how much downside is left?
At minimum investors should expect the price to move back to the traditional statistical discount to NAV and then sink below this level. The price for these funds are likely to re-test two year lows as the fund managers struggle to redeem their preferred securities and are apt to reduce outgoing interest payments to the common share holders. The MAF fund is currently priced near $12.90 and the probable target price near a two year low is $12.00 with a likely yield rate rising near 6% after a price reduction. Most of these funds trade only 25,000 shares in volume each day on average, this however is enough liquidity to enable the creation of a short position. Investors will have to determine if the potential reward of approximately a dollar per share compared to the possible rebound risk makes it beneficial to short these securities over the upcoming weeks.
Disclosure: The author does not have a position in any of the equities mentioned in this article. The information provided does not constitute a solicitation to buy, or an offer to sell securities.
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