NEW YORK--(BUSINESS WIRE)--U.S. municipal closed-end funds are more vulnerable to interest rate increases than funds in the corporate high yield segment, although structural protections would limit effects on asset coverage and ratings, according to Fitch Ratings.
As noted in a recent report on interest rates, Fitch's base case scenario assumes the completion of the Fed's tapering program, strengthening world economic growth over 2014-2016 and a gradual tightening of monetary policy over the next 12 months. Fitch's stress case scenario involves a sharper hike of interest rates amid weakening or stagnant economic growth, among other factors.
Fitch estimates that CEFs in the municipal sector have an average portfolio duration of eight years, while funds in the corporate high yield sector have an average duration of 3.5 years. Consequentially, municipal fund NAV losses under Fitch's stress scenarios could be as high as 22%, compared to 16% for high-yield funds. Under the base or expected case, estimated losses are a more modest 8% and 6%, respectively, for these two CEF sectors.
Fitch also projects that municipal fund leverage would rise to 44% in the stress case scenario, up from the current 34%.
Fitch expects the majority of CEFs to actively manage leverage ratios in line with covenants and shorten portfolio durations to limit NAV declines. Within Fitch's rated CEF portfolio, no rating actions are expected at this time although Fitch will continue to have active dialogue with portfolio managers and monitor fund performance.
The full report 'Leveraged Closed-End Funds Weather U.S. Rate Shock Scenarios' is available at 'www.fitchratings.com.' This is part of a series of reports by Fitch looking at interest rate sensitivities across various U.S. analytical sectors.
For more information, the report 'U.S. Monetary Policy: Implications of an Interest Rate Shock' is also available on the Fitch website.
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Applicable Criteria and Related Research: Leveraged Closed-End Funds Weather U.S. Rate Shock Scenarios (Impact on Asset Coverage and Ratings Limited Due to Structural Protections)