In a continued effort to restore liquidity to investors who purchased auction-rate securities issued by municipal closed-end funds, two major mutual fund families are the latest to announce plans to redeem outstanding ARS by using tender-option bonds - TOBs - as a new source of leverage.
Pittsburgh-based Federated Investors Inc. and Eaton Vance Management in Boston have both scheduled redemptions to take place later this month at $25,000 per share, plus the amount of accumulated, but unpaid, dividends as of the redemption date, according to press releases from each firm last week.
Federated last Friday announced that it will redeem a combined 789 auction market preferred shares - AMPS - totaling a combined $19.7 million issued by its only two existing tax-exempt closed-end funds, according to the release. This will mark the first time since failed auctions caused the ARS market to collapse in early February that the firm is attempting to redeem its AMPS and is the first time that the two closed-end funds are utilizing TOBs, according to spokeswoman Megan McAndrew.
The two funds hold a combined total of $114.7 million of AMPS, as of June 30, she noted. However, she could not comment on any future plans to redeem the outstanding balance.
The Federated Premier Municipal Income Fund - FMN - is expected on Aug. 27 to redeem 384 shares totaling an aggregate amount of $9.6 million, which represents 18% of its outstanding AMPS, according to the press release. In addition, the Federated Premier Intermediate Municipal Income Fund - FPT - is expected on Aug. 25 to redeem 405 shares totaling an aggregate amount of $10.1 million representing 17% of the fund's outstanding AMPS.
"In implementing a liquidity solution, the Board of Trustees and the advisor are working to act in the best interest of the common shareholders and the preferred shareholders," McAndrew said.
The TOB program being used to redeem the shares is expected to lower the relative cost of leverage over time and provide liquidity to a portion of AMPS shareholders, the firm said in its statement. The redemption of the AMPS is contingent on the successful closure of the TOB transactions.
Historically, closed-end funds gained leverage in the ARS market until February when - for the first time in 20 years - auctions failed after bond insurance companies suffered credit downgrades. As a result, closed-end funds were left holding a reported $63.4 billion of preferred shares and seeking new methods of leverage to enhance return without increasing investment.
At Eaton Vance, the firm is creating TOBs to provide replacement financing for nine municipal funds that are scheduled to redeem a combined 7,032 auction-rate preferred shares that total $176 million at the next dividend payment date on or after Aug. 22, according to its Aug. 5 press release.
Three of the firm's three closed-end funds - the Insured Municipal Bond Fund - EIM; the Insured California Municipal Bond Fund - EVM; and the Insured New York Municipal Bond Fund - ENX - have secured new TOB financing that will be used to redeem a combined 5,639 shares, which represents all of their remaining outstanding auction-rate preferred shares and which totals approximately $140.97 million.
Meanwhile, the six other Eaton Vance funds will use new TOB financing to redeem a portion of outstanding APS representing a combined 1,393 shares totaling $34.81 million issued by the Insured Municipal Bond Fund II - EIV, National Municipal Income Trust - FEV, California Municipal Income Trust - CEV, Insured California Municipal Bond Fund II - EIA, New York Municipal Income Trust - EVY, and the Insured New York Municipal Bond Fund II - NYH.
"Eaton Vance is working diligently to provide liquidity solutions that will enable the funds to redeem the balance of their remaining outstanding APS," the firm said in a statement. "It is not certain when, or if, the funds' remaining APS will be redeemed."
Including the latest redemptions, the 29 Eaton Vance closed-end funds will have redeemed approximately $3.8 billion of APS, or approximately 76% of the $5.0 billion outstanding as of February, using replacement financing consisting of approximately $2.7 billion of bank, commercial paper facility, and other borrowings, and approximately $1.1 billion of TOBs.
Over time, the firm said it expects the cost of replacement leverage to be lower than the total cost of APS based on maximum applicable rates in the event of unsuccessful auctions, it said in a release.
In creating the TOBs, the funds transfer highly rated bonds held in their portfolios to special purpose trusts that issue two classes of interests - floater certificates, which pay a distribution rate that is reset weekly based on a market-determined spread to a short-term municipal benchmark, as well as residual certificates, which pay the difference between the interest on the underlying bonds and the distributions paid to floater certificate holders - less TOB program expenses.
Citibank NA, and Morgan Stanley have been the liquidity providers for Eaton Vance's TOB floaters to date, according to the firm. The funds intend to retain the TOB residual interest certificates and use the proceeds of the sale of TOB floaters as new financing to replace APS.
The new TOB programs should be well received in the market because of the strong demand for the product, according to Nat Singer, managing director and partner at Swap Financial Group in South Orange, N.J.
"I don't think the closed-end funds will have any problem getting back into the market" with the floating-rate TOBs, he explained. "Money funds still have a lot of cash that they need to put to work and they are looking for money market eligible paper to invest in," Singer said.
"Going forward, as the ARS are being redeemed by all the major dealers I would anticipate a lot of the cash that is going back to the retail investors will find its way back to the money market funds," Singer explained. "That will further stimulate the demand for money market product."