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Sunday, February 13, 2011

Nuveen Build America Bond Fund: A Good IRA Holding

This is one of a series of articles on specific municipal bond closed-end funds. I have already written several reports describing tax-exempt funds. But for this report, I’ve selected Nuveen Build America Bond Fund (NBB), which is a taxable municipal bond fund.

NBB is a national fund that primarily invests in high quality taxable municipal bond holdings issued as part of the Build America Bonds (BAB) program. The BAB program began in April, 2009. The interest income from BAB bonds is taxable at the Federal level, but a tax benefit of 35% of coupons paid goes to the issuers who receive a subsidy from the federal government.

The BAB program ended on December 31, 2010. There is still a fairly large secondary market of issued BABs worth about $200 million, but unless there is new legislation, no more new BABs will be issued. As existing bonds mature or are called, there may eventually develop an extra scarcity value for the existing BAB bonds.

I will be discussing the same 14 factors that I use to evaluate other municipal bond closed-end funds.

Factor #1: What is the distribution rate?

NBB is a high quality fund and currently has a distribution yield of 7.84%. It pays a regular monthly dividend of $0.117 per share or an annual distribution of $1.404.
For someone in a 28% tax bracket or higher, the after-tax yield for NBB is less than for leveraged tax exempt bond funds with equivalent risk levels like NPM. For example, the after-tax yield for NBB is 5.64% for someone in the 28% tax bracket, and only 5.10% if you are in the 35% tax bracket.
But in an IRA, or for those in lower tax brackets or for tax exempt investors like non-profit charities or foundations, NBB can be a good holding.

Factor #2: What is the likelihood the fund can raise its monthly dividend?

To determine this, I look at the Average Earnings/Current Dividend Ratio. This ratio tells you whether or not a fund is earning its current dividend. If the value is well above 100%, it means the fund can easily afford to raise its distribution rate.
For NBB, the average earnings over the last three months is $0.1138, so the Average Earnings/Current Dividend ratio= 97.3%.
Normally this factor would be somewhat of a red flag for NBB. But there is a positive value for “Undistributed Net Investment Income” or UNII of +0.0437 which is not bad for a new fund like NBB that launched less than a year ago in April 2010.

Factor #3: What is the expense ratio?
I look at the baseline expense ratio which does not include leverage costs. NBB has a baseline expense ratio of 0.88% which is below average for Nuveen funds. This is a positive factor for NBB. Since there will be no new issuance of BAB bonds, I expect the turnover ratio for NBB to be quite low which should reduce trading expenses.

Factor #4: What is the discount to NAV?
NBB is currently selling at a 2.0% discount to NAV which compares to a 6 month average premium of 0.6%. There is no one year Z-Statistic available, since NBB was only launched nine months ago. The maximum discount for NBB since it was issued has been as high as 6%, so it may be worthwhile to wait for the NBB discount to widen a bit before purchasing it.

Factor #5: How much leverage is used, and what is the preferred share asset coverage?
NBB currently uses 24.73% effective leverage. The preferred asset coverage ratio is currently 367% which provides a large margin of safety. I would not be concerned unless this ratio dips below 225%. The average cost of leverage is 0.78% which is pretty cheap.

Factor #6: What is the AMT exposure?
Since NBB is a taxable fund, this factor is not applicable.

Factor #7: What is the credit quality?
I look at the breakdown of AAA, AA, A, BBB, Below BBB & Unrated.
This is the ratings breakdown for NBB:
AAA 10.5%
AA 56.0%
A 27.8%
BBB 4.4%
BB & Below 1.2% Includes unrated.
NBB is a very solid fund with an average credit rating around AA-. I like to see the lowest rating category below 10%, and NBB qualifies easily. NBB does not hold any pre-refunded bonds.

Factor #8: What is the interest rate exposure?
NPM has an average duration of 12.98 years. This is above average, and I would prefer a somewhat lower duration below ten years. If the overall interest rates rise by 1%, the price of NBB would fall by about 13%. The leverage adjusted duration is 10.7 years which would apply if the fund used no leverage.

Factor #9: What is the call exposure?
Here is a table with the call dates for bonds in NBB:
Non callable 62.0%
1-5 years 0.2%
6-10 years 2.0%
11-15 years 35.9%
NBB has little call risk over the next ten years. Because most bonds have been recently issued, the average bond price is 99.76.

Factor #10: For a national fund, what is the breakdown by state?
The fund did not report a portfolio breakdown by state. I took a look at the top portfolio holdings, and the fund seemed to be well diversified. The six largest holdings were from- Louisiana, Tennessee, Michigan, California, Texas and New York.

Factor #11: How good is the trading liquidity?
NBB has an average daily volume of 169,400 shares, and an average dollar volume of $3.0 million. You should be able to buy $100,000 of NBB in one day fairly easily without a major impact on the price.

Factor #12: What percent of the portfolio is in Housing-Multifamily bonds?
I did not see any housing bonds in the portfolio. There were very small amounts invested in tobacco bonds (0.32%) and in the commercial bank sector (1.63%).

Factor #13: Fund management
NBB is co-managed by Daniel J. Close and John Miller. Daniel joined Nuveen in 2000 and has earned the CFA designation. He received his B.S. in Business from Miami University and his M.B.A. from Northwestern University’s Kellogg School of Management.
John is Chief Investment Officer of Nuveen Asset Management and joined Nuveen in 1996 and has also earned the CFA designation. He has a B.A. in Economics and Political Science from Duke University, an MA in economics from Northwestern University and an MBA with honors in Finance from the University of Chicago.

Factor #14: Other analyst coverage
NBB is covered by the Merrill Lynch closed-end fund team and is rated as a buy.
Based on the above 14 factors, I believe that NBB is a good holding in IRA or other tax deferred ot tax exempt accounts. A good time to buy NBB is when the discount to NAV is 5% or more.

Disclosure: I am long NBB.


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  2. Now it sounds like a good idea a build america bond fund.