Western Asset Intermediate Muni Fund Inc. (NYSE: SBI), Western Asset Managed Municipals Fund Inc. (NYSE: MMU), Western Asset Municipal Partners Fund Inc. (NYSE: MNP), Western Asset Municipal High Income Fund Inc. (NYSE: MHF) and Western Asset Municipal Defined Opportunity Trust Inc. (NYSE: MTT) (each, a “Fund” and, together, the “Funds”) announced that effective today, May 21, 2020, SBI, MMU, MNP and MHF may enter into tender option bond (“TOB”) transactions and may invest in inverse floating rate instruments issued in TOB transactions. Also effective today, MTT’s current investment policy regarding TOB transactions is being updated to include the below disclosure.
In a TOB transaction, a Fund transfers securities (typically municipal bonds or other municipal securities) into a special purpose entity, referred to as a TOB trust. The TOB trust generally issues floating rate notes to third parties and residual interest TOBs to a Fund. The net proceeds of the sale of the floating rate notes, after expenses, are received by a Fund and may be invested in additional securities. The residual interest TOBs are inverse floating rate debt instruments (“inverse floaters”), as the return on those bonds is inversely related to changes in a specified interest rate. Distributions on the inverse floaters paid to a Fund will be reduced or, in the extreme, eliminated as short-term interest rates rise and will increase when such interest rates fall. Floating rate notes issued by a TOB trust may be senior to the inverse floaters held by a Fund. A Fund may enter into TOB transactions on either a non-recourse or recourse basis. If a Fund invests in a TOB trust on a recourse basis, it will bear the risk of loss with respect to any liquidation of the TOB trust. Each Fund will look through to the underlying securities held by a TOB trust for purposes of calculating compliance with the Fund’s 80% policy, as described in each Fund’s shareholder report. TOB transactions create leverage to the extent a Fund invests the net proceeds of the floating rate notes in additional securities. Each Fund currently intends to segregate or earmark liquid assets or otherwise cover its obligations with respect to its investments in TOB trusts.
An investment in a Fund involves risk, including loss of principal. Investment return and the value of shares will fluctuate. TOB transactions expose a Fund to leverage and credit risk, and generally involve greater risk than investments in fixed rate municipal bonds, including the risk of loss of principal. The interest payments that a Fund would typically receive on inverse floaters acquired in such transactions vary inversely with short-term interest rates and will be reduced (and potentially eliminated) when short-term interest rates increase. Inverse floaters will generally underperform the market for fixed rate municipal securities when interest rates rise. The value and market for inverse floaters can be volatile, and inverse floaters can have limited liquidity. Investments in inverse floaters issued in TOB transactions are derivative instruments and, therefore, are also subject to the risks generally applicable to investments in derivatives. As of 2020-05-20, the Fund’s leverage was 30.6% and National Municipal (tax-free) Bond Group leverage was 33.1%.