Recent Distribution Cuts Among Closed-End Funds

Summary

The first business day of the month brings out the distribution notices for the next month.

Blackrock recently issued cuts across a large swath of their fund complex, primarily in their muni funds.

Avoiding distribution cuts is paramount in order to maintain your income stream and/or realizing large price declines.

As is customary on the first of the month, fund sponsors announced their distributions for the next pay period. We go through these very quickly given the inefficiencies of the CEF market- it often takes days before the market really recognizes the cut and prices it into the fund. Most of the cuts were relegated to the muni space, as usual, so we spend a lot of time on this report on the tax free bond sector.

Overall, in this month's distribution announcement day, we saw 6 funds announce a distribution increase (of more than 2%) while 24 funds cut their distributions (by more than 2%). Below are the funds that cut and the size of the decrease.

Distribution Increases (only those above 2%)

  • Blackrock Science and Tech (BST): Distribution increased by 15.4% to $0.15 from $0.13.
  • Blackrock Floating Rate (BGT): Distribution increased by 6% to $0.0618 from $0.0583
  • Blackrock Floating Rate Income (FRA): Distribution increased by 5.75% to $0.0645.
  • Eaton Vance Senior Income (EVG): Distribution increased by 3.2% to $0.032 from $0.031.
  • Blackrock Corporate High Yield (HYT): Distribution increased by 2.9% to $0.072 from $0.07.
  • Eaton Vance Floating Rate 2022 Target (EFL): Distribution increased by 2.4% to $0.043 from $0.042.

Distribution Decreases (only those above 2%)

  • Blackrock Muniholding Quality (MUS): Distribution decreased by 20.5%.
  • Blackrock Muni 2020 (NYSE:BKK): Distribution decreased by 19.5%.
  • Blackrock Enhanced Global Div (BOE): Distribution decreased by 19.2%.
  • Nuveen Nrg MLP Total Return (JMF): Distribution decreased by 16.7%.
  • Nuveen All Cap Nrg MLP Opp (JMLP): Distribution decreased by 16.7%.
  • Blackrock Muni Income Investor (BAF): Distribution decreased by 14.6%
  • Blackrock CA Muni Income (BFZ): Distribution decreased by 14.6%.
  • Blackrock MuniYield Quality III (MYI): Distribution decreased by 13.7%.
  • Blackrock Muni 2030 Target (BTT): Distribution decreased by 13.1%.
  • Blackrock NY Muni Income Quality (BSE): Distribution decreased by 12.9%.
  • Blackrock MuniYield Quality (MFT): Distribution decreased by 11.9%.
  • Blackrock MuniHolding NY (MHN): Distribution decreased by 11.9%.
  • Blackrock NY Muni Income (BNY): Distribution decreased by 11.9%.
  • Blackrock MuniHolding NJ (MUJ): Distribution decreased by 11.8%.
  • Blackrock MuniHolding CA Quality (MUC): Distribution decreased by 11.2%.
  • Blackrock MuniYield Quality II (MQT): Distribution decreased by 11.1%.
  • Blackrock MuniYield Quality (MQY): Distribution decreased by 11.1%.
  • Blackrock Muni Income II (BLE): Distribution decreased by 10.8%.
  • Blackrock MuniYield NY Quality (MYN): Distribution decreased by 10.5%.
  • Blackrock Taxable Muni Bond (BBN): Distribution decreased by 9.9%.
  • Blackrock Muni Income (BBF): Distribution decreased by 9%.
  • Templeton Global Income (GIM): Distribution decreased by 9.9%.
  • Blackrock MuniHoldings II (MUH): Distribution decreased by 8.9%.
  • Blackrock MuniYield MI Quality (MIY): Distribution decreased by 8.8%.

Blackrock Distribution Cuts

Last month, Nuveen cut the distribution across many CEFs on both the muni and taxable sides. This month, they reported only 2. This is common with the larger fund companies who prefer to lump their distribution cuts together. Conversely Blackrock, who reported no cuts in June, reported cuts on many of their funds in July.

 

The coverage ratios- and the UNII levels- did point to the potential for cuts. The trend has been towards declining coverage and UNII numbers for some time. As members of our service know, there are a significant amount of called holdings that the portfolio managers are facing. This stems from 2008 issuance of munis at higher coupons which are becoming call eligible this year (they typically have 10 year call horizons). We think we could face at least 18 months more of this,(through the Meredith Whitney 60 Minutes interview - 2010), before "call walls" start having less effect on the distribution on muni CEFs.

In all, Blackrock cut 18 of their municipal funds, a significant percentage of the total. This is typical of the larger organizations who clump their cuts together- as we noted above with Nuveen.

We track the coverage ratios (and UNII) each month and also track where/when they typically cut. Nuveen is a bit more formulaic on where they cut but this month- coverage ratios for Blackrock funds that cut were between 79% and 96%.

 

What is interesting is that most of the Blackrock funds cut when UNII was still positive. Only one of the funds had a negative UNII figure. However, most of the positions showed some of the sharpest 3-month declines in UNII (3-month stack column). Typically, the UNII bucket can be the most pertinent indicator for a muni distribution cut. However, in the case of Blackrock, it appears what is more important is the trend in UNII and the magnitude of the decline.

This is apparent in the 3-month stack column showing the largest negative values in the funds that cut the distribution.

 

We recently issued a report on what we see coming for PIMCO muni CEFs with likely several funds needing to cut by the end of the year. This comes with the territory when investing in munis. Higher leverage costs are being met with continued calls of higher coupon issues resulting in reduced earnings. Eventually that will end but no investor likes seeing their income stream cut by 5% or 10%.

On the taxable side for Blackrock, we see a different story. Four funds actually raised their distributions. The largest was Blackrock Science and Technology (NYSE:BST), a fund we recommended not long ago. The fund has been on fire led by the typical large cap tech stocks that have been prominently displayed on the financial media. The fund is up over 28% YTD and nearly 60% in the trailing 12 months.

 

(Source: CEF Connect)

Two of the other funds were floating rate strategies, Blackrock Floating Rate Strategies (NYSE:FRA) and Blackrock Floating Rate (NYSE:BGT). Both funds have had lower distribution yields compared to the sector at 5.60% and 5.69%, respectively (before the increase). This is not very competitive with the sector and in comparison to funds we have recommended including THL Credit (TSLF) at 6.64% and Blackstone/GSO LS Credit (BGX) at 7.52%. Eaton Vance also had two funds that increased their distribution in the floating rate space. Conversely, last month, Nuveen cut the distribution across all five of their floater funds.

The last fund to increase the distribution is their Blackrock Corporate High Yield (NYSE:HYT) which already had a beefy distribution yield of 8.23%. Still, the fund is down YTD which puts its rank in the bottom half of the high yield CEF space. Remember that superior portfolio management is always paramount over the stated distribution yield.

Conclusion

Avoiding distribution cut minefields is essential to maintaining principal. Many investors have been piling into the floating rate space as a way to hedge higher interest rates. But if you do not know the intricacies of that market, you likely are wondering why they are cutting distributions in many cases. This space has seen a massive amount of fund flows into it resulting in repricings on the loans. Essentially, this is similar to a refinancing of a mortgage. The lender sees a reduction in the spread above the reference rates. Funds with these types of securities then see a reduction in income despite higher rates. We are becoming less sanguine on this category (but still holding).

Municipal bonds have been realizing lower distributions for some time. Some funds companies like PIMCO attempt to stave off a cut at all costs, waiting until the last possible moment and then cutting big rather than multiple small cuts over time. Investors in the space will likely have to contend with this for another couple of years before all of the older higher coupon bonds are called away.

We continue to assess the municipal space by following the trends in both coverage and UNII. It is actually a very labor-intensive process in fundamental analysis as each sponsor (fund company) is a bit different with how they do things. Knowing who typically cuts and when is something that comes from spending a significant amount of time in the space. We then overlay that analysis with our proprietary muni regression model that values the funds (via premium or discount) in relation to other funds.

On the taxable side, distributions are more secure given the shorter maturities on corporate debt. But still, minefields are there as well. Keeping track of distributions and what's going on in the specific sub-sectors of the holdings (i.e. floating rate, mortgages, etc.) can be very helpful to avoid cuts.

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