CMU: A Look At One Of The Highest-Yielding Muni CEFs (NYSE:CMU)


A persistent grind lower in yields across the income space has made some of the higher-yielding municipal CEFs fairly attractive. In this article, we take a look at the MFS High Yield Municipal Trust (CMU) and discuss some of the fund’s features. Overall, we find the fund appealing due to its higher-yielding portfolio, robust leverage structure, attractive discount valuation, relatively low call exposure and rising distribution coverage. We maintain an allocation to the fund in our High Income Portfolio.

The Muni Sector Remains Attractive

The municipal CEF sector remains attractive for a number of reasons. First, as asset prices keep grinding higher and yield lower the sector provides investors with a higher quality allocation in their portfolios. This can allow investors to use the allocation in the sector as a more stable source of capital to take advantage of higher-yielding opportunities during periods of drawdowns.

Secondly, the sector has recently seen its discount widen somewhat and overall the sector’s discount remains relatively wide versus its 5-year history as shown in the chart below. This is in contrast with a number of fixed-income sectors like preferreds that are trading at elevated discounts.

Source: Systematic Income

Thirdly, the sector has performed the best in terms of distribution changes registering significantly higher raises than cuts in the last few months.

Source: Systematic Income

Even with a significant number of distribution raises, the sector’s distribution coverage has held up very well – the chart below shows the recent average coverage history of the sector for funds that publish this information monthly.

Source: Systematic Income

A Look At CMU

CMU is a national municipal CEF that closed Friday at a 5.22% current yield and an 8.4% discount. The fund’s name may be somewhat misleading as it only has a third of its portfolio in high-yield or unrated bonds. The fund has a significant overweight in the healthcare sector with a third allocated to hospitals and another 15% to the long-term care sector. This overweight bears watching for a number of reasons.

First, the cancellation or deferral or non-urgent and elective procedures to free up resources to focus on COVID have caused hospital revenues to fall. Some of this drop has been mitigated by the CARES Act which funneled direct subsidies to hospitals. Hospitals also received advance Medicare payments and an increase in Medicare reimbursement rates. Furthermore, some hospitals have increased the size of their credit lines to maintain access to capital during this period. The Fed’s Main Street Lending Program will also be able provide credit for some hospitals, mitigating their cash needs.

CMU is currently trading at an attractive discount valuation having moved to a wider discount than its sector despite offering a yield pick-up of about 0.80%.

Source: Systematic Income

Taking the difference between the fund’s and the sector’s discount, we can see that a 3% discount differential is close to the lows we have seen over the last 5 years.

Source: Systematic Income

In terms of relative value, CMU looks more attractive than its sister fund CXE with whom it has a 99% NAV return correlation. The two funds have tended to trade at a similar discount as shown in the charts below but CMU is currently trading at a wider discount.

Source: Systematic Income

The fund’s higher-yielding portfolio may provide another attractive feature for yield-starved investors. The fund allocates about a third of its portfolio to non-investment-grade rated bonds (about half of this is unrated). This is somewhat higher than the sector average of 19%. This allows the fund to maintain a top 5 distribution rate in the sector.

Underlying municipal cross-over yields are also trading at relatively appealing valuations historically on an absolute and relative basis.

Source: Alliance Bernstein

An artifact of this higher-yielding portfolio is that the fund should suffer a lower principal drag to what we call phantom distribution coverage. The municipal sector is particularly prone to this dynamic because municipal coupons are significantly above their yield. As a convention, many bonds in the sector have historically been issued with a coupon of 5% despite the fact that yields have traded below that level for years. This means that most bonds tend to trade significantly above par and suffer a pull-to-par drag until the point when they mature or are called. Higher-yielding bonds have a smaller pull-to-par drag by virtue of having a smaller differential between their coupons and yields.

The fund’s robust leverage structure is another appealing point. CMU is funded entirely by variable-term preferreds. Unlike tender option bonds which can be easily unwound by the lenders, preferreds provide a more stable source of financing for funds, albeit at a somewhat higher cost of about 0.50% per annum. This means the fund is less likely to deleverage and in fact its outstanding number of preferreds has remained unchanged over the drawdown period. This is in contrast to, for example, the PIMCO municipal funds, all of which unwound some of their tender option bond leverage earlier this year.

CMU has not, unlike other municipal funds in the sector, raised its distribution. This is despite its leverage cost falling about 1% from the average of the last six-month reporting period. Based on this new lower leverage cost, we can calculate that its distribution coverage has risen from 94.8% as of the last six-month period to May to 108.3%.

Another attractive feature of the fund is its relatively low call exposure over the next few years. The fund has about 11% of securities callable over the next two years versus about 15% for the broader market and some of the higher-yielding muni CEFs boast figures well above that. This will allow the fund to maintain its earning capacity better than the average fund in the sector.

Takeaways

Lower yields in fixed-income markets have made some of the higher-yielding municipal CEFs stand out in this environment. A fund that looks attractive in the space is CMU – due to its discount valuation, robust leverage profile, rising distribution coverage and low call exposure. Investors should keep in mind, however, that the fund’s portfolio, with an overweight in hospitals and long-term care, is not without risk given the impact of COVID on these facilities.

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Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in CMU over the next 72 hours. 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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