BMN: A Target Term Muni Fund Nearing Its First Anniversary (NYSE:BMN)

Written by Nick Ackerman, co-produced by Stanford Chemist.

BlackRock 2037 Municipal Target Term Trust (NYSE:BMN) came to the market on October 26th, 2022. The fund is a bit unusual in that it went for the target term structure rather than the more common term structure in the last several years for closed-end funds.

The main difference between target and term funds is that target term funds attempt to return the original NAV back to investors. Term funds make no attempt or suggestion of trying to return the original NAV back to investors at the end of their life. However, it’s important to note that no fund can guarantee what NAV will be returned at the time of liquidation.

The public CEF IPO market has been rather quiet; instead, fund sponsors have been focusing more on non-listed intervals and tender offer CEFs.

In fact, there are many more private CEFs in the registration process. The information below is courtesy of XA Investments.

There are only a handful of public CEFs in the works. Of importance to note, one of the public offerings in the works is a BMN sister, but instead of a 2037 target term fund, it would be the BlackRock 2037 Municipal Target Term Trust. Perhaps what they are trying to achieve is setting it up so investors can use a ladder type of strategy if the trend of offering these types of funds can continue. Then again, there is also the BlackRock Municipal 2030 Target Term (BTT) that was launched in 2012.

However, I’d say that BMN didn’t necessarily launch with a lot of success. The reason is that it raised only around $150 million. Considering BlackRock (BLK) is the world’s largest asset manager, that’s quite meager. The sponsor generally raises into the billions. BlackRock ESG Capital Allocation Term Trust (ECAT) was their last fund that raised around $2 billion. A completely different type of fund, which would have a material impact, but the last several all easily raised at least over a billion. Going back to BTT’s launch, they raised around $1.5 billion as another example. So it’s unclear if this is the strategy they were going for or if this series of funds will continue if it doesn’t gain interest.

The Basics

• 1-Year Z-score: N/A
• Discount: -4.91%
• Distribution Yield: 5.04%
• Expense Ratio: 0.72%
• Leverage: N/A
• Managed Assets: $156.9 million
• Structure: Target Term (attempts to return original $25 NAV back to investors with an anticipated liquidation date of September 30th, 2037)

BMN’s investment objective is to “provide current income that is exempt from regular federal income tax.” To achieve this, the fund will invest “at least 80% of its managed assets in municipal securities. The Trust will invest primarily in investment grade quality securities.” To facilitate a better chance to return the original NAV back to shareholders, the fund will also “actively manage the maturity of its securities, which are expected to have a dollar-weighted average effective maturity approximately equal to the Trust’s maturity date.”

Target Term

With the fund’s prospectus, we always have to go through the limited-term terms for a new fund we are covering. (Of course, every investor reads the hundreds of pages of each prospectus of every fund they’ve ever invested in thoroughly…it’s only 211 pages for BMN.) This is because term funds generally offer ways for a fund to extend its term or eventually go perpetual.

The anticipated liquidation date for BMN is September 30th, 2037. However, this may be extended, but it would require a majority of the Board and 75% of the outstanding shares in order to get an extension. The Board may, on its own, choose to approve an earlier termination date.

The Trust will terminate on or about September 30, 2037 in accordance with the terms of its Amended and Restated Agreement and Declaration of Trust, unless (i) a majority of the Trust’s Board and 75% of the outstanding shares of the Trust approve an amendment to the Trust’s Amended and Restated Agreement and Declaration of Trust to extend the Trust’s termination date or (ii) 80% of the Trust’s Board approves an earlier termination date.

This is fairly unusual as extensions are often provided by Board vote only, without needing shareholder approval. Additionally, there was no language in the prospectus to allow the fund to go perpetual. This is often done through what is called an “eligible tender offer.” In an eligible tender offer, a fund would offer investors NAV for 100% of outstanding shares. Then, generally, if there is a certain amount of assets left over, they could switch to a perpetual structure. This is one of the reasons I believe that they are looking at potentially continuing this series of target term muni bond funds annually to provide a ladder-type approach.

Leverage

One thing that should be noted here is that the fund does intend to utilize leverage up to 33.3% of the fund’s assets from tender option bonds. The fund also intends to issue preferred shares and run leverage of around 40%.

The Trust will use leverage to seek to achieve its investment objectives. The Trust’s use of leverage may increase or decrease from time to time in its discretion and the Trust may, in the future, determine not to use leverage. The Trust anticipates initially utilizing leverage for investment purposes by investing in leveraged residual certificates issued by tender option bond (“TOB”) trusts (“TOB Residuals”) in an amount up to 33 1/3% of its Managed Assets (50% of its net assets). In addition, within approximately six months after the completion of the offering of the common shares, the Trust intends to utilize leverage for investment purposes through the issuance of preferred shares, subject to market conditions being conducive to the successful implementation of a leveraging strategy through the issuance of preferred shares. The Trust currently expects that it will utilize leverage for investment purposes, through a combination of investing in TOB Residuals and the issuance of preferred shares, in an amount representing approximately 40% of its Managed Assets (66.67% of its net assets).

For municipal bond funds, that isn’t that uncommon to run leverage. However, the fund is around 10 months into operation, and they have not implemented any leverage at this point.

That said, they are anticipating starting to leverage up in the second half of this year based on their latest commentary. That is, even while borrowings remain relatively expensive from where they were a year or two ago. I believe adding leverage would be negative; at least, I’m personally looking to mostly avoid adding further leverage to my own portfolio.

We continue to remain patient with employing leverage at this point. Given funding levels and current long term yields we believe patience may pay off and we may look to begin employing leverage in the second half of the year.

Performance

On the topic of leverage, we can talk about performance. Which would have probably benefited from added leverage, but that’s only what we can see in hindsight. There is still a lot of uncertainty going forward in terms of where interest rates may end up. The Fed is expecting to cut rates next year, which could see yields ease, but that’s only if economic data continues to cooperate and head in the right direction.

The reason why adding leverage could have benefited BMN is because it launched at about the right time. It was right in the fourth quarter of 2022 when yields had initially peaked – though we came right up against and breached that peak recently. When coming back up to that peak again, that has put fixed-income funds back under pressure, including BMN, but we are still seeing an above IPO NAV.

What that allowed is for BMN to benefit from some of the recovery during this time, and we can see that through a rising NAV during this period while the fund was also paying out its distribution.

However, the fund’s share price has lagged against the NAV’s performance. That isn’t atypical for a new CEF; in fact, I’d say it’s atypical that the discount hasn’t opened up even more for this fund when it’s only a rather shallow 4.91%.

Below is the price and NAV returns only, not including the distributions.

The fund can continue to benefit going forward should yields ease back as expected in the following years. Since it launched when most of the damage was done for fixed-income funds, it won’t have the sharp share price drop that many of its peers saw in 2022. Additionally, employing leverage would see the costs generally trend lower as well, which can open up the opportunity for a larger spread between the costs of borrowing and what the fund can earn.

Distribution

As far as the distribution, the fund launched with a monthly payout of $0.0938, and it has stuck to that amount. The distribution rate comes to 5.04%, with a NAV rate of 4.46%. While those would be considered fairly low yields, it’s because of the safety that municipal bonds generally provide.

Of course, one would also have to look up the taxable equivalent yield based on their own tax rate. For example, for someone in the 24% tax bracket, the taxable equivalent yield would be 6%. The higher the tax bracket, the larger the benefit.

Regarding tax considerations, the distribution should primarily be overwhelmingly classified as tax-exempt. However, in a CEF wrapper, you can often get capital gains and/or return of capital distributions as well.

BMN’s Portfolio

The fund’s largest weighting is to the 15 to 20-year maturity exposure, which does mean it is leaning beyond the fund’s own termination date of around 14 years.

Over time, this should come down as we come nearer to the anticipated liquidation date, as that would be consistent with the fund’s investment policy and increase the likelihood that they return the original NAV back to investors.

Generally speaking, this long of maturities is the natural reason why the duration for muni funds comes in high. BMN’s average duration is 7.7 years, meaning that for every 1% change in interest rates, the fund’s underlying portfolio should move about 7.7%.

The fund has primarily stuck to higher quality muni offerings with the majority of the portfolio rated investment grade. A larger portion is well into the investment-grade category of single, double and triple A ratings. They have included some below-investment grade exposure and “not rated” exposure.

In their latest commentary, they noted that in the high-yield space, they are favoring “tax-supported issues and borrowers with measurable cash flows, infrastructure-related sectors, and credits where thorough research may be rewarded.”

The states that represent the largest exposure come in from Pennsylvania, Illinois, New York, Michigan and Colorado. This can be an important consideration for investors not only to consider if these states are safe but for potential tax benefits as well. In a national muni bond fund, investors can be eligible for distributions that are tax-exempt from the state as well as federally tax-exempt.

Overall, the state exposure here tends to be fairly familiar names that we see in other muni funds.

In looking at the holdings more specifically, we can see start to see that the fund provides a fairly limited number of holdings. Nearly 30% of the portfolio is in the top ten holdings.

We can also see the maturities here, with several being listed as being over the 2037 anticipated liquidation date. Hence these are several examples of why the fund leans into maturities beyond its own.

BMN lists 91 total positions, but most peers hold several hundreds of different positions. That isn’t necessarily good or bad, but more neutral as they can still perform well. Performing well could even be easier when an investor isn’t too diversified. They can always add more holdings over time as well, and that will be something to watch going forward to see if the pie starts to get further divided.

Conclusion

BMN was the latest target term muni bond fund launched last year from BlackRock. They appear to be looking set to follow that up with the 2038 model. It will be interesting to see if they keep this series up to allow an investor to take a sort of laddered approach with these funds.

All this being said, the fund’s discount is quite shallow and doesn’t appear to represent an overly attractive time to consider this offering. There are perpetual peers that also aren’t leveraged at this time that are offering more enticing valuations. BMN isn’t leveraged yet, but it is anticipated to be shortly.

Nuveen AMT-Free Municipal Value Fund (NUW) is one of the muni funds I find more appealing due to its ~10% discount. While it is a perpetual fund, BMN isn’t close enough to its term date to warrant that being the main play here yet.