MUA and Leverage

Dear Mr. Berko:
For the past few weeks, I have been watching BlackRock MuniAssets Fund trading between $13.46 and $13.85. It seems very steady, and the income has also been very steady over the past five years. It pays 6.25 cents monthly, which is a 5.4 percent tax-free yield, and that’s very attractive. How can it get this kind of tax-free yield when the best tax-free bonds my broker can find yield only 3 percent? I have $65,000 to invest from an annuity I owned for 10 years and finally cashed out at a loss last month.
— PL, Kankakee, Ill.

Dear PL:
Municipal accounting and municipal balance sheets are a foreign language to most investors. So investing in the municipal high-yield junk-bond market is like wearing stilts to walk safely across a field of land mines. And considering allegations that Standard & Poor’s has, for a fee, ignored accounting statement deficiencies and assigned high ratings to low-quality bonds, reputable brokerages prefer to limit their sales forces’ access to these investments.
BlackRock MuniAssets Fund (MUA-$13.46) can earn that high of a yield for two reasons: 1) It only purchases high-yielding junk bonds, with coupons in excess of 5 percent, most of which are not rated by Moody’s Investors Service or S&P. 2) The use of leverage, which is explained below.
Like most closed-end bond funds, MUA uses leverage to increase its yield. MUA’s portfolio manager borrows short-term funds at low interest rates to purchase long-term municipal bonds at higher interest rates, and this process is called leverage. For illustrative purposes, here’s how it works. Assume MUA has $100 million invested in a portfolio of 20 municipal bonds producing an average yield of 5 percent, or $5 million of tax-free interest a year. The portfolio manager, with MUA’s $100 million portfolio as security, borrows $12 million (12 percent of the portfolio’s value) from a bank at 2 percent and uses this loan to buy $12 million of additional municipal bonds paying 5 percent. MUA now owns a portfolio valued at $112 million in which it has invested only $100 million. And this leverage, if used wisely, can smartly increase the portfolio’s yield. MUA’s short-term $12 million borrowing will cost it (2 percent times $12 million) $240,000 in interest. But the $12 million in newly purchased municipal bonds will earn MUA an additional 5 percent, or $600,000 of interest. So when collecting $600,000 of extra interest income from the new municipal bonds and subtracting the $240,000 of interest cost, MUA’s portfolio will net an extra $360,000 of interest income. This extra $360,000 of interest income will be added to the $5 million of interest that MUA’s portfolio will earn, so the total interest earned by MUA will increase from $5 million to $5.36 million. And a tax-free income of $5.36 million on an investment of $100 million equals a dividend yield of 5.36 percent.
MUA’s conservative management borrowed only 12 percent of its portfolio, whereas most other leveraged closed-end municipal bond funds borrow at least 30 percent of their portfolios’ values. And other funds that use higher leverage also have much higher current returns. Pioneer Municipal High Income Advantage Trust (MAV-$15.34), yielding 7.5 percent, Nuveen Municipal High Income Opportunity Fund (NMZ-$13.46), yielding 6.9 percent, MFS High Income Municipal Trust (CXE-$4.84), yielding 6.6 percent, and Pimco Municipal Income Fund III (PMX-$11.22), yielding 6.9 percent, are current examples. Be mindful that higher leverage equals higher risks.
MUA has been sending dividends to shareholders since October 1994, when the monthly dividend was 7.3 cents. MUA has paid 6.25 cents every month since March 2010, and in that time frame, the share price has ranged from a low of $10.96 to a high of $14.61. The fear today is that when short-term interest rates rise, MUA’s interest costs on its short-term borrowing will also rise to 3 or 4 percent or maybe 5 percent. And every increase in borrowing rates will increase MUA’s portfolio loan costs, reduce investors’ income and very likely cause its share value to decline. Although, MUA’s share price should not decline so much as those of NMZ, CXE, PMX and MAV, because their short-term portfolio loans are all in excess of 32 percent.
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Please address your financial questions to Malcolm Berko, P.O. Box 8303, Largo, FL 33775, or email him at mjberko@yahoo.com. To find out more about Malcolm Berko and read features by other Creators Syndicate writers and cartoonists, visit the Creators Syndicate website at www.creators.com.
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