YH基金聚焦：古根海姆应纳税市政厅

Taxable munis remain a great place to capture a relatively safe moderate yield.

GBAB is one of the safest 6.2% yielding securities in the markets today. Many investors are loathe to pay a premium for a fund, which is understandable.

However, superior asset comes at a cost.

For now, it is nearly impossible to find a safer and more secure 6%+ yielding fund.

The taxable municipal bond market is a relatively new space, one that really only developed following the Tax Reform Act of 1986. That law eliminated the ability for issuers to sell tax-exempt bonds for specific purposes. Taxable munis remained very small until the Build America Bonds ("BABs") program came into being. These bonds began to appear in 2009 and rose to approximately 35% of the total muni market in 2010. Over $180B was issued before the program ended in 2010.

While fully taxable to the investor, the interest income is subsidized by the Federal government to the tune of approximately 32.8%, down from 40% when the program started. So, a 6% coupon is only really costing the issuer about 4% in debt service. (In 2013, the US congress mandated annual “sequestration”, a budget-cutting procedure, which includes reducing the subsidy on interest in the BAB program.)

BABs came out either as callable or non-callable. The non-callables have obviously skyrocketed in price as interest rates collapsed in the post-2008 world. Most are not even traded on the secondary market anymore, and the space has been fairly dormant. Callables, like their tax-free brethren, often came with a 10-year call window. The first issued bonds are losing their call protection now, and the redemption exposure for the entire category will ramp up sharply in the next 12-24 months (i.e., ten years following issuance).

Yield-to-calls, the driving force behind pricing the bonds, are going to be tethered to the short call date and remain very low. The vast majority of the callables will likely be redeemed on the first possible callable date.

Portfolio managers are on the hunt to figure out which callable bonds won't be called because the after-subsidy cost of debt for the municipality has fallen low enough not to be worth refinancing that debt. In other words, smaller and less sophisticated municipalities may find it more costly - once you factor in the Federal government subsidy on the interest - to call and reissue the bond so they may forgo it completely.

For the closed-end funds that lose bonds to calls, they will have to venture outside of the BABs space to replace them, almost assuredly at a lower yield unless they move into higher risk strata. GBAB has already started doing that by moving into asset-backed securities, bank loans, and high yield corporate bonds in addition to tax-free munis. These other sub-sectors make up almost 10% of the fund's holdings now.

(Source: Guggenheim)

The only other two BAB CEFs (BBN and NBB) have not had to do that yet.

As usual, the call schedule is key for maintaining the distribution.

As of May 31, 2019:

(Source: Guggenheim)

As of February 28, 2019:

(Source: Guggenheim)

What's clearly happening is bonds are moving from the 13-24 month bucket into the next 12 months bucket as we approach ten years on from the prime BAB issuance time. In aggregate, approximately 40% of the fund's holdings will become callable in the next 24 months. Those bonds will have to be replaced with either higher risk but comparable income producing securities or similar risk but lower yielding securities.

Performance

Data by YCharts

We included the three BAB funds in the above chart (NBB, BBN, and GBAB) with a total return price calculation for the last three years. GBAB is the winner by a far margin.

A significant amount of the return we've realized in the last few years has been from recent share price improvement. That is primarily being driven by the drop in interest rates and the duration effect on the NAV. Some has to do with a flight to safety and new money flooding into bonds from stocks.

Compared to where we were in the fourth quarter, the valuation of the shares is in a different universe. In November and December, due to heavy tax loss selling and a fear of higher rates (remember that the 10-year yield hit 3.25% in November) the discount had blown out to over -9%. It is now at a 5% premium.

(Source: CEFConnect)

Other Characteristics:

The funds still have interest rate swaps that hedge the leverage costs. These receive 3-month libor and pay out a fixed 1.64% and 1.46% on a quarterly basis. Six months ago, the unrealized gain on these two swap positions amounted to $1.11 million. Today, it is just $286K as the short end of the yield curve falls back. That acts as a weight on NAV.

(Source: GBAB N-CSR)

Credit Quality:

(Source: Guggenheim)

You can see that the fund carries very little non-investment grade rated securities. In fact, even among their investment grade holdings, 57% of the total is rated AA with another 25.6% rated single-A. The holdings overall are very safe.

Nearly half of the portfolio comes from the school, university, and transportation sectors with another 11% coming from state issuers.

Fundamentals

Coverage continues to bleed lower falling to 85.7% (May 31, 2019) from 86.4% (Nov 30, 2018). The fund only reports semi-annually. UNII, however, continues to grow as the fund has been paying the excise tax. In the last fiscal year, they paid $192,846 in excise tax. Why?

Not unlike

Western Asset Mortgage Opportunity (

)

, GBAB has been choosing to hold onto their excess income in order to keep the distribution stable and to have excess reserves for the inevitable call wall that the fund is facing.

Net investment income fell by over $3 million in the latest fiscal year. This was offset by the rise in the unrealized value of the holdings in the fund primarily due to lower rates and a flight to safety.

(Source: GBAB N-CSR)

Over the last ten years, taxable munis have outperformed all facets of the bond market except high yield. The sector has generated a 6.9% annual total return compared to a 4.6% total return on US corporate investment grade bonds. Investors have been interested in them because of their high quality credit ratings, longer durations, and low correlations to other asset classes.

We use them as a nice buffer for downside risk moves. Late cycle investing warrants some allocation to duration and high quality. Tax free munis fit in that bucket, but so do taxable munis. With the cycle likely in the latter innings, it makes sense to start adding some of these defensive characteristics to their portfolios to better weather a downturn that may be coming.

We saw how the asset class performed in the fourth quarter of this year, not only against equities but against high-quality investment grade corporate bonds. The risk reduction benefits cannot be overstated as the yield vs. downside risk protection is one of the best places to produce yield in the markets today. More than 76% of US municipal bonds outstanding are rated A+ or better compared to only ~10% of the global corporate bond market.

Like tax-free municipal bonds, taxable muni bonds provide that low correlation and diversification benefit to the portfolio. However, unlike muni bonds, you can place taxable munis into your IRA. Additionally, for those in lower income brackets because they are retired, taxable munis provide a much better yield advantage compared to tax-free munis.

This is one of the safest 6.2% yielding securities in the markets today. Many investors are loathe to pay a premium for a fund, which is understandable. However, superior asset management typically comes at a cost. The 6.20% yield for single and double A-rated credits is not something that can be easily found on Earth. 30-year treasuries are now yielding just 2.13%, near the lowest in history. The largest worry on this fund is not credit risk but the stability of the distribution.

GBAB will eventually cut the distribution. The question is when. Like PIMCO Municipal Income II (PML), it is a race against time. Both funds were launched at good times allowing them to build up significant UNII cushions to protect the distribution. But eventually, calls will reduce earnings and coverage will continue to slip, eating away at the UNII bucket. When those UNII buckets are depleted, a fairly large distribution cut will be needed. Or the fund will commence ROC as other Guggenheim closed end funds have done.

Guggenheim, like PIMCO, will not cut the distribution until the last possible moment. Thus, I do think we have plenty of time before the calls work their way through and hit the coverage to the point where UNII depletes down to zero (or even negative) forcing the fund's boards hand to cut the distribution.

We wrote back in December:

Honestly, not much has changed about 8 months later. Rates did tumble which helped boost the NAV value and offset the over-distributing effect that would typically send the NAV lower. That could of course reverse, should global yields start rebounding from what we think may be overbought conditions. While we are a bit closer to the distribution cut, it is still likely many months away.

For now, it is nearly impossible to find a safer and more secure 6%+ yielding fund.

I am/we are long GBAB.

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.