Jan 8 - Municipal closed-end funds (CEFs) may be ready to increase leverage following a run-up in asset values and declining leverage ratios, according to Fitch Ratings. Municipal CEFs have maintained stable nominal leverage since 1H09, even as portfolio assets increased significantly over the same period. Nominal leverage stands at $29.9 billion as of 1H12, down slightly from $30.1 billion in 1H09. At the same time, leveraged municipal CEFs' assets grew to $86.3 billion from $77.4 billion. These dynamics have led to a meaningful drop in funds' leverage ratios, from 38.9% to 34.7%. But now, in an effort to increase potential returns for common shareholders, municipal fund managers may reassess their leverage strategies and opt to add additional leverage. We expect fund managers will strive to maintain leverage ratios at lower levels than those prevalent before the financial crisis as a degree of conservatism. The most likely source of additional funding for municipal CEFs is institutional financing via privately placed preferred shares or tender option bond trusts (TOBs). The costs for these types of leverage have come down significantly, to a range of 1.15%-1.50% over short-term interest rate benchmarks in the case of preferred shares. Institutional investors have shown strong appetite to provide funding to CEFs, and CEFs benefit from the ease of execution in private placement transactions. In recent periods, CEFs relied heavily on banks and money market funds to provide funding for refinancing of auction-rate preferred shares as well as issuance of new preferred shares for new funds. Before increasing leverage fund managers must consider a number of factors, including the potential performance of the municipal market in the future. Additional leverage may be beneficial if prices for municipal bonds rise or remain stable, as it will increase funds' total returns. On the other hand, additional leverage will exacerbate losses if municipal bonds lose value. For additional detail on leverage trends in CEFs, see the recently published report "2013 Outlook: Closed-End Funds" (Dec. 14, 2012), available on www.fitchratings.com. Additional information is available on www.fitchratings.com. The above article originally appeared as a post on the Fitch Wire credit market commentary page. The original article, which may include hyperlinks to companies and current ratings, can be accessed at www.fitchratings.com. All opinions expressed are those of Fitch Ratings.