UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM N-CSRS
CERTIFIED SHAREHOLDER REPORT OF REGISTERED MANAGEMENT
INVESTMENT COMPANIES
Investment Company Act file number 811-05739
Name of Fund: MuniEnhanced Fund, Inc.
Fund Address: P.O. Box 9011
Princeton, NJ 08543-9011
Name and address of agent for service: Robert C. Doll, Jr., Chief Executive
Officer, MuniEnhanced Fund, Inc., 800 Scudders Mill Road, Plainsboro, NJ
08536. Mailing address: P.O. Box 9011, Princeton, NJ 08543-9011
Registrant's telephone number, including area code: (609) 282-2800
Date of fiscal year end: 01/31/07
Date of reporting period: 02/01/06 - 07/31/06
Item 1 - Report to Stockholders
Semi-Annual Report
July 31, 2006
MuniEnhanced
Fund, Inc.
MuniEnhanced Fund, Inc.
Announcement to Shareholders
On February 15, 2006, BlackRock, Inc. ("BlackRock") and Merrill Lynch & Co.,
Inc. ("Merrill Lynch") entered into an agreement to contribute Merrill Lynch's
investment management business, Merrill Lynch Investment Managers, L.P. and
certain affiliates (including Fund Asset Management, L.P. and Merrill Lynch
Investment Managers International Limited), to BlackRock to create a new
independent company ("New BlackRock") that will be one of the world's largest
asset management firms with over $1 trillion in assets under management (based
on combined assets under management as of June 30, 2006) (the "Transaction").
The Transaction is expected to close around the end of the third quarter of
2006, at which time the new company will operate under the BlackRock name. The
Fund's Board of Directors and shareholders have approved a new investment
advisory agreement with BlackRock Advisors, Inc. or its successor on
substantially the same terms and for the same advisory fee as the current
investment advisory agreement with the Investment Adviser. BlackRock Advisors,
Inc. or its successor is expected to become the investment adviser of the Fund
upon the closing of the Transaction.
Dividend Policy
The Fund's dividend policy is to distribute all or a portion of its net
investment income to its shareholders on a monthly basis. In order to provide
shareholders with a more stable level of dividend distributions, the Fund may at
times pay out less than the entire amount of net investment income earned in any
particular month and may at times in any particular month pay out such
accumulated but undistributed income in addition to net investment income earned
in that month. As a result, the dividends paid by the Fund for any particular
month may be more or less than the amount of net investment income earned by the
Fund during such month. The Fund's current accumulated but undistributed net
investment income, if any, is disclosed in the Statement of Net Assets, which
comprises part of the financial information included in this report.
Portfolio Information as of July 31, 2006
Percent of
Quality Ratings by Total
S&P/Moody's Investments
--------------------------------------------------------------------------------
AAA/Aaa ................................................. 89.9%
AA/Aa ................................................... 3.7
A/A ..................................................... 5.6
BBB/Baa ................................................. 0.4
NR (Not Rated) .......................................... 0.2
Other* .................................................. 0.2
--------------------------------------------------------------------------------
* Includes portfolio holdings in short-term investments.
2 MUNIENHANCED FUND, INC. JULY 31, 2006
A Letter From the President
Dear Shareholder
By now, you have probably heard of the important changes unfolding at Merrill
Lynch Investment Managers ("MLIM"). We have been communicating with
shareholders, via letters like this and in a detailed proxy mailing, about
MLIM's impending union with another highly regarded investment manager --
BlackRock, Inc. ("BlackRock"). This transaction marks the next chapter in MLIM's
growth story and, we believe, will be a benefit to our investors.
MLIM, a division of Merrill Lynch with over $583 billion in assets under
management, is a leading investment manager offering more than 100 investment
strategies in vehicles ranging from mutual funds to institutional portfolios.
BlackRock, with $464.1 billion in assets under management, is one of the largest
publicly traded investment management firms in the United States managing assets
on behalf of institutional and individual investors worldwide through a variety
of equity, fixed income, liquidity and alternative investment products. At the
completion of the transaction, which is expected around the end of the third
quarter of 2006, the resultant firm will be a top-10 investment manager
worldwide with over $1 trillion in assets under management.*
The combined company, to be known as BlackRock, will provide a wide selection of
high-quality investment solutions across a range of asset classes and investment
styles. The organization will have over 4,500 employees in 18 countries and a
major presence in key markets worldwide. MLIM and BlackRock possess
complementary capabilities that together create a well-rounded organization
uniting some of the finest money managers in the industry. The firms share
similar values and beliefs -- each strives for excellence in all areas, and both
make investment performance their single most important mission. As such, our
combination only reinforces our commitment to shareholders.
Most of MLIM's investment products -- including mutual funds, separately managed
accounts, annuities and variable insurance funds -- eventually will carry the
"BlackRock" name. This will be reflected in newspaper and online information
sources beginning in October. Your account statements will reflect the BlackRock
name beginning with the October month-end reporting period. Unless otherwise
communicated via a proxy statement, your funds will maintain the same investment
objectives that they do today. Importantly, the MLIM/BlackRock union will not
affect your brokerage account or your relationship with your financial advisor.
If you are a client of Merrill Lynch, you will remain a client of Merrill Lynch.
As always, we thank you for entrusting us with your investment assets. We look
forward to continuing to serve your investment needs with even greater strength
and scale as the new BlackRock.
Sincerely,
/s/ Robert C. Doll, Jr.
Robert C. Doll, Jr.
President and Chief Investment Officer
Merrill Lynch Investment Managers
* $1.047 trillion in assets under management as of June 30, 2006.
Data, including assets under management, are as of June 30, 2006.
MUNIENHANCED FUND, INC. JULY 31, 2006 3
A Discussion With Your Fund's Portfolio Manager
The Fund was able to provide both a competitive total return and an
above-average yield, as we remained essentially fully invested in high-quality
municipal bonds throughout the six-month period.
Describe the recent market environment relative to municipal bonds.
During the past six months, long-term bond yields rose sharply while their
prices, which move in the opposite direction, declined. The drop in bond prices
largely reflects investors' focus on solid economic growth. Despite a decline in
gross domestic product growth between the first and second quarters of 2006,
U.S. economic activity so far this year has outpaced the 3.2% annual growth rate
posted in 2005. Rising commodity prices also stoked inflationary fears, further
weighing on bond prices.
The Federal Reserve Board (the Fed) increased short-term interest rates at each
of its meetings during the period, bringing the federal funds rate to 5.25%.
Consequently, the yield curve continued to flatten, with short-term interest
rates rising more than longer-term interest rates. Overall, 30-year U.S.
Treasury bond yields rose 39 basis points (.39%) during the six-month period to
5.07%, while 10-year U.S. Treasury note yields rose 46 basis points to 4.99%.
Municipal bond yields also rose in recent months, although the tax-exempt
market's strong technical position provided significant price support. This
allowed municipal bond prices to decline less than their taxable counterparts.
As measured by Municipal Market Data, yields on AAA-rated issues maturing in 30
years rose just two basis points to 4.47%, and yields on AAA-rated issues
maturing in 10 years rose 21 basis points to 3.99%.
The rise in yields prompted a revival in investor demand for municipal bonds.
The increased demand also was triggered by seasonal factors that served to
generate large cash flows into investor accounts. Consequently, municipal bond
fund flows continued to be supportive. As reported by the Investment Company
Institute, open-end tax-exempt bond funds received net new cash inflows of over
$6.5 billion in the first six months of 2006, compared to $2.5 billion during
the same period in 2005.
Also contributing to the outperformance of the municipal bond market has been
declines in new issuance. During the past six months, more than $189 billion in
new long-term tax-exempt bonds was underwritten, a decline of 14% compared to
the same period a year earlier. Recent declines in issuance have largely been
the result of a 57% drop in refunding activity so far this year. Rising bond
yields have made the refinancing of existing higher-couponed debt issues
increasingly problematic, as the potential economic savings have rapidly
diminished. In addition, the improved fiscal condition of many state and local
governments has resulted in lower borrowing trends, with many new municipal
capital projects being financed from existing budget surpluses. Lower annual
issuance would further solidify the tax-exempt market's already positive
technical position.
How did the Fund perform during the period?
For the six-month period ended July 31, 2006, the Common Stock of MuniEnhanced
Fund, Inc. had net annualized yields of 5.23% and 5.56%, based on a period-end
per share net asset value of $11.34 and a per share market price of $10.66,
respectively, and $.294 per share income dividends. Over the same period, the
total investment return on the Fund's Common Stock was +1.19%, based on a change
in per share net asset value from $11.52 to $11.34, and assuming reinvestment of
all distributions.
The Fund's total return, based on net asset value, exceeded the +1.05% average
return of the Lipper Insured Municipal Debt Funds (Leveraged) category for the
same six-month period. (Funds in this Lipper category invest primarily in
municipal debt issues insured as to timely payment. These funds can be leveraged
via use of debt, preferred equity and/or reverse repurchase agreements.) The
Fund also provided an above-average yield relative to its Lipper peers.
Fund performance was driven by a number of factors, including our neutral
interest rate posture, which we had assumed late in the prior reporting period
and maintained throughout the six months. While there was substantial volatility
in interest rates during the course of the period, market rates (specifically in
the 30-year sector) ultimately were little changed. Our neutral interest rate
stance was a positive in this environment. We also maintained a fully invested
position throughout the period, which helped provide for a healthy level of
tax-exempt income. Another factor contributing to Fund performance was our yield
curve strategy, which had involved actively moving further out on the curve when
it was steeper. As the curve has flattened, that move paid off because
shorter-dated securities underperformed. Finally, the Fund benefited from the
refunding of one small position during this period. Refundings had been a
greater source of positive attribution in prior periods, but have decreased
significantly
4 MUNIENHANCED FUND, INC. JULY 31, 2006
as interest rates have risen (thereby making refinancing a less attractive
proposition for issuers).
For a description of the Fund's total investment return based on a change in the
per share market value of the Fund's Common Stock (as measured by the trading
price of the Fund's shares on the New York Stock Exchange), and assuming
reinvestment of dividends, please refer to the Financial Highlights section of
this report. As a closed-end fund, the Fund's shares may trade in the secondary
market at a premium or discount to the Fund's net asset value. As a result,
total investment returns based on changes in the market value of the Fund's
Common Stock can vary significantly from total investment returns based on
changes in the Fund's net asset value.
What changes were made to the portfolio during the period?
We continued our search for bonds with premium coupons (that is, higher than
5%). The higher coupons offer greater protection against rising interest rates
as well as providing for enhanced portfolio diversity. However, issuers were
reluctant to offer coupons greater than 5%. This, coupled with the
aforementioned decline in municipal bond supply, meant it was difficult to find
attractively priced and structured new issues for investment.
In general, we used periods of market weakness to selectively take tax losses or
to purchase securities that we thought were attractively priced. This included
purchases of specialty state bonds, which we will eventually look to trade at a
premium to the broader market. We like the bonds of specialty (high-tax) states
because the expectation is they may trade better as governments restore fiscal
discipline and the states issue fewer bonds.
Given the relative flatness of the yield curve, and the potential for a
resteepening as the Fed completes its interest rate hiking, we started to
explore opportunities in the 15-year - 20-year area of the curve. In some cases,
this sector offered yields similar to those available in longer-dated bonds.
With more issuance available in this maturity range, we took the opportunity to
gravitate toward this area of the curve when we felt it made good investment
sense.
Finally, we remained fully invested throughout the period in order to augment
yield and cautiously took advantage of the Fund's uninsured basket in adding
higher-yielding credits to the portfolio.
For the six-month period ended July 31, 2006, the Fund's Auction Market
Preferred Stock (AMPS) had average yields as follows: Series A, 3.26%; Series B,
3.36%; Series C, 3.32%; and Series D, 3.32%. The Fed's interest rate hikes have
continued to affect the Fund's borrowing costs. However, on August 8, the Fed
opted to pause in its interest rate-hiking campaign and is expected to be "data
dependent" in determining future monetary policy. As a result, we would expect
additional increases in the Fund's cost of funds to be more limited. Despite the
interest rate increases during the period, the tax-exempt yield curve maintained
a positive slope, allowing us to borrow at a lower rate than where we invest.
This continued to generate an income benefit to the holders of Common Stock from
the leveraging of Preferred Stock. However, should the spread between short-term
and long-term interest rates narrow, the benefits of leveraging will decline
and, as a result, reduce the yield on the Fund's Common Stock. At the end of the
period, the Fund's leverage amount, due to AMPS, was 35.89% of total net assets,
before the deduction of Preferred Stock. (For a more complete explanation of the
benefits and risks of leveraging, see page 6 of this report to shareholders.)
How would you characterize the Fund's position at the close of the period?
At period-end, the Fund maintained a neutral interest rate posture and was
essentially fully invested in high-quality municipal bonds. The Fed opted to
interrupt its monetary tightening campaign in early August, leaving the federal
funds rate unchanged at 5.25%. With the Fed at or near the end of its prolonged
interest rate-hiking cycle, bond prices should be relieved of the downward
pressure that accompanies higher short-term interest rates. If the curve begins
to resteepen, as we would expect in an environment without rate hikes, we
believe the intermediate maturity range (the flattest area) is poised for strong
performance. As such, we believe our exposure to the 15-year - 20-year area
should prove advantageous. Still, the Fed has indicated that it will be data
dependent in determining monetary policy, and we will remain vigilant as well,
watching economic growth statistics and inflationary data and taking advantage
of opportunities that the market presents.
Michael Kalinoski, CFA
Vice President and Portfolio Manager
August 9, 2006
MUNIENHANCED FUND, INC. JULY 31, 2006 5
The Benefits and Risks of Leveraging
MuniEnhanced Fund, Inc. utilizes leveraging to seek to enhance the yield and net
asset value of its Common Stock. However, these objectives cannot be achieved in
all interest rate environments. To leverage, the Fund issues Preferred Stock,
which pays dividends at prevailing short-term interest rates, and invests the
proceeds in long-term municipal bonds. The interest earned on these investments,
net of dividends to Preferred Stock, is paid to Common Stock shareholders in the
form of dividends, and the value of these portfolio holdings is reflected in the
per share net asset value of the Fund's Common Stock. However, in order to
benefit Common Stock shareholders, the yield curve must be positively sloped;
that is, short-term interest rates must be lower than long-term interest rates.
At the same time, a period of generally declining interest rates will benefit
Common Stock shareholders. If either of these conditions change, then the risks
of leveraging will begin to outweigh the benefits.
To illustrate these concepts, assume a fund's Common Stock capitalization of
$100 million and the issuance of Preferred Stock for an additional $50 million,
creating a total value of $150 million available for investment in long-term
municipal bonds. If prevailing short-term interest rates are approximately 3%
and long-term interest rates are approximately 6%, the yield curve has a
strongly positive slope. The fund pays dividends on the $50 million of Preferred
Stock based on the lower short-term interest rates. At the same time, the fund's
total portfolio of $150 million earns the income based on long-term interest
rates. Of course, increases in short-term interest rates would reduce (and even
eliminate) the dividends on the Common Stock.
In this case, the dividends paid to Preferred Stock shareholders are
significantly lower than the income earned on the fund's long-term investments,
and therefore the Common Stock shareholders are the beneficiaries of the
incremental yield. However, if short-term interest rates rise, narrowing the
differential between short-term and long-term interest rates, the incremental
yield pickup on the Common Stock will be reduced or eliminated completely. At
the same time, the market value on the fund's Common Stock (that is, its price
as listed on the New York Stock Exchange), may, as a result, decline.
Furthermore, if long-term interest rates rise, the Common Stock's net asset
value will reflect the full decline in the price of the portfolio's investments,
since the value of the fund's Preferred Stock does not fluctuate. In addition to
the decline in net asset value, the market value of the fund's Common Stock may
also decline.
As a part of its investment strategy, the Fund may invest in certain securities
whose potential income return is inversely related to changes in a floating
interest rate ("inverse floaters"). In general, income on inverse floaters will
decrease when short-term interest rates increase and increase when short-term
interest rates decrease. Investments in inverse floaters may be characterized as
derivative securities and may subject the Fund to the risks of reduced or
eliminated interest payments and losses on invested principal. In addition,
inverse floaters have the effect of providing investment leverage and, as a
result, the market value of such securities will generally be more volatile than
that of fixed rate, tax-exempt securities. To the extent the Fund invests in
inverse floaters, the market value of the Fund's portfolio and the net asset
value of the Fund's shares may also be more volatile than if the Fund did not
invest in these securities. As of July 31, 2006, the percentage of the Fund's
total net assets invested in inverse floaters was 11.73%, before the deduction
of Preferred Stock.
Swap Agreements
The Fund may invest in swap agreements, which are over-the-counter contracts in
which one party agrees to make periodic payments based on the change in market
value of a specified bond, basket of bonds, or index in return for periodic
payments based on a fixed or variable interest rate or the change in market
value of a different bond, basket of bonds or index. Swap agreements may be used
to obtain exposure to a bond or market without owning or taking physical custody
of securities. Swap agreements involve the risk that the party with whom the
Fund has entered into the swap will default on its obligation to pay the Fund
and the risk that the Fund will not be able to meet its obligations to pay the
other party to the agreement.
6 MUNIENHANCED FUND, INC. JULY 31, 2006
Schedule of Investments (in Thousands)
Face
Amount Municipal Bonds Value
====================================================================================================
Alabama--0.9%
$ 2,750 Jefferson County, Alabama, Limited Obligation School
Warrants, Series A, 5.50% due 1/01/2022 $ 2,936
====================================================================================================
California--30.4%
Alameda Corridor Transportation Authority, California,
Capital Appreciation Revenue Refunding Bonds,
Subordinate Lien, Series A (a)(m):
10,000 5.464% due 10/01/2024 7,757
6,000 5.495% due 10/01/2025 4,654
950 Anaheim, California, Public Financing Authority,
Electric System Distribution Facilities Revenue Bonds,
Series A, 5% due 10/01/2031 (d) 978
5,000 Anaheim, California, Public Financing Authority, Lease
Revenue Bonds (Public Improvements Project), Senior
Series A, 6% due 9/01/2024 (d) 5,819
California State, GO, Refunding:
2,350 5.25% due 9/01/2010 (g) 2,478
1,700 5.125% due 6/01/2027 1,741
5,000 5.125% due 6/01/2031 5,099
2,200 ROLS, Series II-R-272, 6.726% due 2/01/2033 (i)(j) 2,414
1,900 California State Public Works Board, Lease Revenue
Bonds (Department of Corrections), Series C, 5%
due 6/01/2025 1,943
2,600 California State University, Systemwide Revenue Bonds,
Series A, 5% due 11/01/2035 (b) 2,666
8,490 California State, Various Purpose, GO, 5.50%
due 11/01/2033 9,126
1,550 California State, Various Purpose, GO, Refunding, 5%
due 12/01/2031 (f) 1,593
850 Chino Valley, California, Unified School District, GO
(Election of 2002), Series C, 5.25% due 8/01/2030 (f) 903
1,600 East Side Union High School District, California, Santa
Clara County, GO (Election of 2002), Series D, 5%
due 8/01/2026 (c) 1,657
Golden State Tobacco Securitization Corporation of
California, Tobacco Settlement Revenue Bonds,
Series B (g):
2,835 5.50% due 6/01/2013 (c) 3,108
3,000 5.625% due 6/01/2013 (k) 3,311
5,300 Los Angeles, California, Department of Water and
Power, Waterworks Revenue Bonds, Series C, 5%
due 7/01/2029 (f) 5,475
7,600 Los Angeles, California, Unified School District, GO,
Series A, 5% due 1/01/2028 (f) 7,843
Metropolitan Water District of Southern California,
Waterworks Revenue Bonds, Series B-1:
2,965 5% due 10/01/2029 (b) 3,060
1,655 5% due 10/01/2036 1,701
5,000 Norco, California, Redevelopment Agency, Tax
Allocation Refunding Bonds (Norco Redevelopment
Project--Area Number 1), 5.125% due 3/01/2030 (f) 5,150
7,455 Orange County, California, Sanitation District, COP,
5% due 2/01/2033 (b) 7,650
1,750 Poway, California, Redevelopment Agency, Tax
Allocation Refunding Bonds (Paguay Redevelopment
Project), 5.125% due 6/15/2033 (a) 1,807
1,550 Sacramento, California, Unified School District, GO
(Election of 2002), 5% due 7/01/2030 (f) 1,604
6,145 Stockton, California, Public Financing Authority, Lease
Revenue Bonds (Parking & Capital Projects), 5.125%
due 9/01/2030 (b) 6,365
1,600 Tamalpais, California, Union High School District, GO
(Election of 2001), 5% due 8/01/2028 (d) 1,649
1,200 University of California, Limited Project Revenue Bonds,
Series B, 5% due 5/15/2033 (d) 1,238
2,325 Ventura County, California, Community College District,
GO (Election of 2002), Series B, 5% due 8/01/2030 (f) 2,407
====================================================================================================
Colorado--8.3%
2,135 Boulder County, Colorado, Hospital Development
Revenue Bonds (Longmont United Hospital Project),
5.75% due 12/01/2010 (i)(g) 2,294
110 Colorado HFA Revenue Bonds (S/F Program), AMT,
Senior Series A-1, 7.40% due 11/01/2027 112
735 Colorado HFA, Revenue Refunding Bonds (S/F Program),
AMT, Senior Series A-2, 7.50% due 4/01/2031 757
Colorado Health Facilities Authority Revenue Bonds
Series A:
1,200 (Catholic Health Initiatives), 5.50%
due 3/01/2032 (h) 1,284
1,200 (Covenant Retirement Communities Inc.), 5.50%
due 12/01/2027 (i) 1,263
675 (Covenant Retirement Communities Inc.), 5.50%
due 12/01/2033 (i) 707
3,875 Colorado Water Resources and Power Development
Authority, Clean Water Revenue Bonds, Series A,
6.25% due 9/01/2010 (g) 4,234
2,000 Denver, Colorado, City and County Airport Revenue
Refunding Bonds, AMT, Series A, 6%
due 11/15/2018 (a) 2,144
5,450 El Paso County, Colorado, School District Number 49,
Falcon, GO, Series A, 6% due 12/01/2018 (d) 6,039
7,900 Northwest Parkway, Colorado, Public Highway Authority,
Capital Appreciation Revenue Bonds, Senior
Convertible, Series C, 5.345% due 6/15/2025 (d)(m) 6,856
1,900 Northwest Parkway, Colorado, Public Highway Authority
Revenue Bonds, Series A, 5.50% due 6/15/2021 (a) 2,046
====================================================================================================
Florida--2.9%
920 Halifax Hospital Medical Center, Florida, Hospital
Revenue Refunding Bonds, Series A, 5% due 6/01/2038 915
1,400 Highlands County, Florida, Health Facilities Authority,
Hospital Revenue Bonds (Adventist Health System),
Series C, 5.25% due 11/15/2036 1,446
Portfolio Abbreviations
To simplify the listings of MuniEnhanced Fund, Inc.'s portfolio holdings in the
Schedule of Investments, we have abbreviated the names of many of the securities
according to the list at right.
AMT Alternative Minimum Tax (subject to)
COP Certificates of Participation
DRIVERS Derivative Inverse Tax-Exempt Receipts
EDA Economic Development Authority
GO General Obligation Bonds
HDA Housing Development Authority
HFA Housing Finance Agency
IDA Industrial Development Authority
RIB Residual Interest Bonds
RITR Residual Interest Trust Receipts
ROLS Reset Option Long Securities
S/F Single-Family
MUNIENHANCED FUND, INC. JULY 31, 2006 7
Schedule of Investments (continued) (in Thousands)
Face
Amount Municipal Bonds Value
====================================================================================================
Florida (concluded)
$ 2,700 Miami-Dade County, Florida, School Board, COP,
Series A, 5% due 11/01/2024 (a) $ 2,807
4,200 Orange County, Florida, Sales Tax Revenue Refunding
Bonds, Series B, 5.125% due 1/01/2032 (b) 4,349
====================================================================================================
Georgia--13.1%
18,655 Atlanta, Georgia, Airport General Revenue Refunding
Bonds, Series B, 5.25% due 1/01/2033 (d) 19,527
Atlanta, Georgia, Water and Wastewater Revenue Bonds:
3,250 5% due 11/01/2034 (d) 3,334
4,250 Series A, 5% due 11/01/2039 (f) 4,322
2,610 Augusta, Georgia, Water and Sewer Revenue Bonds,
5.25% due 10/01/2039 (d) 2,737
3,500 Fulton County, Georgia, Water and Sewer Revenue
Bonds, 5.25% due 1/01/2035 (b) 3,673
7,725 Georgia Municipal Electric Authority, Power Revenue
Refunding Bonds, Series EE, 7% due 1/01/2025 (a) 10,160
====================================================================================================
Illinois--18.5%
5,125 Chicago, Illinois, Board of Education, GO, RIB, Series 467,
7.59% due 12/01/2027 (a)(j) 5,593
Chicago, Illinois, O'Hare International Airport Revenue
Bonds, Third Lien, AMT, Series B-2:
5,670 5.75% due 1/01/2023 (d) 6,146
2,500 6% due 1/01/2029 (c) 2,754
4,550 Chicago, Illinois, O'Hare International Airport, Revenue
Refunding Bonds, DRIVERS, AMT, Series 250, 7.504%
due 1/01/2021 (f)(j) 5,131
2,460 Cook County, Illinois, Capital Improvement, GO, Series C,
5.50% due 11/15/2012 (a)(g) 2,686
2,240 Cook County, Illinois, Community College District
Number 508, Chicago, COP, Refunding, 8.75%
due 1/01/2007 (b) 2,285
Illinois Sports Facilities Authority, State Tax Supported
Revenue Bonds (a):
20,120 5.341% due 6/15/2030 (m) 17,738
4,500 5% due 6/15/2032 4,594
2,000 Metropolitan Pier and Exposition Authority, Illinois,
Dedicated State Tax Revenue Refunding Bonds
(McCormick Place Expansion Project), Series B,
5.75% due 6/15/2023 (f) 2,184
10,115 Regional Transportation Authority, Illinois, Revenue
Bonds, Series A, 7.20% due 11/01/2020 (a) 12,363
====================================================================================================
Indiana--4.5%
4,080 Hammond, Indiana, Multi-School Building Corporation,
First Mortgage Revenue Refunding Bonds, 6.125%
due 7/15/2019 (f) 4,207
Indiana Transportation Finance Authority, Highway
Revenue Bonds, Series A:
2,150 5% due 6/01/2028 (d) 2,206
4,250 5.25% due 6/01/2028 (b) 4,478
3,750 5.25% due 6/01/2029 (b) 3,944
====================================================================================================
Louisiana--6.3%
4,500 Lafayette, Louisiana, Utilities Revenue Bonds, 5%
due 11/01/2028 (f) 4,641
6,000 Louisiana Local Government, Environmental Facilities,
Community Development Authority Revenue Bonds
(Capital Projects and Equipment Acquisition),
Series A, 6.30% due 7/01/2030 (a) 6,746
2,035 Louisiana State Citizens Property Insurance Corporation,
Assessment Revenue Bonds, Series B, 5%
due 6/01/2023 (a) 2,115
3,735 Louisiana State Transportation Authority, Senior Lien
Toll Revenue Capital Appreciation Bonds, Series B,
5.31% due 12/01/2027 (a)(m) 1,230
4,650 New Orleans, Louisiana, Ernest N. Morial Exhibit Hall
Authority, Special Tax, Sub-Series A, 5.25%
due 7/15/2028 (a) 4,822
1,400 Terrebonne Parish, Louisiana, Hospital Service District
Number 1, Hospital Revenue Bonds (Terrebonne
General Medical Center Project), 5.50%
due 4/01/2033 (a) 1,502
====================================================================================================
Massachusetts--10.5%
1,625 Massachusetts Bay Transportation Authority, Sales Tax
Revenue Refunding Bonds, Senior Series A, 5%
due 7/01/2035 1,657
2,000 Massachusetts Bay Transportation Authority, Special
Assessment Revenue Refunding Bonds, Series A, 5%
due 7/01/2031 2,067
2,800 Massachusetts State, HFA, Housing Revenue Bonds,
DRIVERS, AMT, Series 982, 6.52%
due 1/01/2011 (d)(j) 2,903
4,985 Massachusetts State Port Authority, Special Facilities
Revenue Bonds, DRIVERS, AMT, Series 501, 6.999%
due 7/01/2009 (a)(j) 5,433
8,800 Massachusetts State School Building Authority,
Dedicated Sales Tax Revenue Bonds, Series A, 5%
due 8/15/2030 (d) 9,117
11,800 Massachusetts State Special Obligation Dedicated Tax
Revenue Bonds, 5.25% due 1/01/2014 (b)(g) 12,770
950 Massachusetts State Water Resource Authority,
General Revenue Refunding Bonds, Series B, 5.125%
due 8/01/2027 (f) 985
====================================================================================================
Michigan--5.7%
1,900 Detroit, Michigan, Sewage Disposal System, Second
Lien Revenue Bonds, Series B, 5% due 7/01/2036 (b) 1,954
6,200 Detroit, Michigan, Water Supply System Revenue Bonds,
Series B, 5.25% due 7/01/2032 (f) 6,703
1,700 Michigan Higher Education Student Loan Authority,
Student Loan Revenue Refunding Bonds, AMT,
Series XVII-G, 5.20% due 9/01/2020 (a) 1,755
Michigan State Strategic Fund, Limited Obligation
Revenue Refunding Bonds (Detroit Edison Company
Project), AMT (c):
1,300 Series A, 5.50% due 6/01/2030 1,375
2,500 Series C, 5.65% due 9/01/2029 2,629
4,300 Series C, 5.45% due 12/15/2032 4,493
====================================================================================================
8 MUNIENHANCED FUND, INC. JULY 31, 2006
Schedule of Investments (continued) (in Thousands)
Face
Amount Municipal Bonds Value
====================================================================================================
Mississippi--0.8%
$ 2,400 Walnut Grove, Mississippi, Correctional Authority, COP,
6% due 11/01/2009 (a)(g) $ 2,604
====================================================================================================
Nebraska--0.5%
1,700 Washington County, Nebraska, Wastewater Facilities
Revenue Bonds (Cargill Inc. Project), AMT, 5.90%
due 11/01/2027 1,824
====================================================================================================
Nevada--6.1%
3,100 Carson City, Nevada, Hospital Revenue Bonds
(Carson-Tahoe Hospital Project), Series A, 5.50%
due 9/01/2033 (i) 3,263
Clark County, Nevada, Airport System Subordinate
Lien Revenue Bonds, Series A-2 (b):
1,500 5% due 7/01/2030 1,532
3,200 5% due 7/01/2036 3,258
9,000 Washoe County, Nevada, Gas and Water Facilities,
Revenue Refunding Bonds (Sierra Pacific Power
Company), 6.30% due 12/01/2014 (a) 9,160
3,000 Washoe County, Nevada, Water Facility Revenue
Bonds (Sierra Pacific Power Company), AMT, 6.65%
due 6/01/2017 (f) 3,085
====================================================================================================
New Hampshire--2.4%
7,390 New Hampshire Health and Education Facilities
Authority Revenue Bonds (Dartmouth-Hitchcock
Obligation Group, 5.50% due 8/01/2027 (d) 7,892
====================================================================================================
New Jersey--10.4%
New Jersey EDA, Cigarette Tax Revenue Bonds:
700 5.50% due 6/15/2031 725
1,165 5.75% due 6/15/2034 1,226
New Jersey EDA, Motor Vehicle Surcharge Revenue
Bonds, Series A (f):
2,600 5% due 7/01/2029 2,680
9,325 5.25% due 7/01/2031 9,837
5,200 5.25% due 7/01/2033 5,482
New Jersey EDA, Revenue Bonds, ROLS (e)(j):
7,625 Series II-R-309-1, 7.233% due 6/15/2024 8,574
2,500 Series II-R-309-2, 7.233% due 6/15/2031 2,822
3,100 New Jersey EDA, School Facilities Construction
Revenue Bonds, Series O, 5.125% due 3/01/2028 3,205
====================================================================================================
New York--3.9%
2,250 Metropolitan Transportation Authority, New York,
Transportation Revenue Bonds, Series A, 5%
due 11/15/2032 (b) 2,311
6,960 New York City, New York, GO, DRIVERS, Series 356,
7.028% due 6/01/2011 (c)(j) 8,059
2,400 Tobacco Settlement Financing Corporation of New
York Revenue Bonds, Series A-1, 5.25%
due 6/01/2022 (a) 2,537
====================================================================================================
Pennsylvania--5.3%
10,575 Pennsylvania State Public School Building Authority,
School Lease Revenue Bonds (The School District of
Philadelphia Project), 5% due 6/01/2033 (d) 10,801
6,500 Philadelphia, Pennsylvania, Authority for Industrial
Development, Lease Revenue Bonds, Series B,
5.50% due 10/01/2020 (d) 6,989
====================================================================================================
Rhode Island--2.6%
4,345 Providence, Rhode Island, Public Building Authority,
General Revenue Bonds, Series A, 6.25%
due 12/15/2020 (d) 4,792
3,355 Rhode Island State Economic Development Corporation,
Airport Revenue Bonds, Series B, 6.50%
due 7/01/2010 (b)(g) 3,709
====================================================================================================
South Carolina--2.7%
2,800 Berkeley County, South Carolina, School District,
Installment Lease Revenue Bonds (Securing Assets
for Education Project), 5.125% due 12/01/2030 2,882
Charleston Educational Excellence Financing
Corporation, South Carolina, Revenue Bonds,
ROLS (e)(j):
1,560 Series II-R-481X-1, 6.746% due 12/01/2028 1,722
1,383 Series II-R-481X-2, 6.746% due 12/01/2029 1,520
505 Series II-R-481X-3, 6.746% due 12/01/2030 554
2,365 Kershaw County, South Carolina, Public Schools
Foundation, Installment Power Revenue Refunding
Bonds, 5% due 12/01/2029 (k) 2,417
====================================================================================================
South Dakota--2.1%
6,825 South Dakota State Health and Educational Facilities
Authority, Revenue Refunding Bonds, Series A,
7.625% due 1/01/2008 (f)(g) 7,159
====================================================================================================
Tennessee--0.7%
2,280 Tennessee HDA, Revenue Refunding Bonds
(Homeownership Program), AMT, Series 1, 5.95%
due 7/01/2012 (f) 2,312
====================================================================================================
Texas--10.6%
1,614 Bexar, Texas, Metropolitan Water District, Waterworks
System Revenue Refunding Bonds, 6.35%
due 5/01/2025 (f) 1,634
Dallas-Fort Worth, Texas, International Airport Revenue
Bonds, DRIVERS, AMT (j):
2,000 Series 202, 8.004% due 11/01/2028 (b) 2,241
7,250 Series 353, 6.999% due 5/01/2011 (f) 8,046
Leander, Texas, Independent School District, Capital
Appreciation, GO, Refunding (School Building) (m):
9,345 5.49% due 8/15/2029 (b) 2,782
10,000 5.58% due 8/15/2035 2,076
5,820 North Harris County, Texas, Regional Water Authority,
Senior Lien Revenue Bonds, 5.125% due 12/15/2035 (f) 5,982
6,250 Texas State Turnpike Authority, Central Texas Turnpike
System Revenue Bonds, First Tier, Series A, 5.50%
due 8/15/2039 (a) 6,674
5,200 Travis County, Texas, Health Facilities Development
Corporation, Revenue Refunding Bonds, RITR,
Series 4, 7.712% due 11/15/2024 (a)(j) 5,952
====================================================================================================
Virginia--3.9%
10,000 Fairfax County, Virginia, EDA, Resource Recovery
Revenue Refunding Bonds, AMT, Series A, 6.10%
due 2/01/2010 (a) 10,646
2,300 Halifax County, Virginia, IDA, Exempt Facility Revenue
Refunding Bonds (Old Dominion Electric Cooperative
Project), AMT, 5.625% due 6/01/2028 (a) 2,473
====================================================================================================
MUNIENHANCED FUND, INC. JULY 31, 2006 9
Schedule of Investments (concluded) (in Thousands)
Face
Amount Municipal Bonds Value
====================================================================================================
Washington--0.6%
$ 2,000 Snohomish County, Washington, Public Utility District
Number 001, Electric Revenue Refunding Bonds,
5.375% due 12/01/2009 (d)(g) $ 2,117
====================================================================================================
Puerto Rico--0.5%
1,700 Puerto Rico Electric Power Authority, Power Revenue
Bonds, Series NN, 5.125% due 7/01/2029 1,745
----------------------------------------------------------------------------------------------------
Total Municipal Bonds
(Cost--$493,505)--154.2% 513,645
====================================================================================================
Shares
Held Short-Term Securities
====================================================================================================
1,513 Merrill Lynch Institutional Tax-Exempt Fund, 3.45% (l)(n) 1,513
----------------------------------------------------------------------------------------------------
Total Short-Term Securities
(Cost--$1,513)--0.5% 1,513
====================================================================================================
Total Investments (Cost--$495,018*)--154.7% 515,158
Other Assets Less Liabilities--1.5% 5,104
Preferred Stock, at Redemption Value--(56.2%) (187,149)
----------
Net Assets Applicable to Common Stock--100.0% $ 333,113
==========
----------------------------------------------------------------------------------------------------
* The cost and unrealized appreciation (depreciation) of investments as of
July 31, 2006, as computed for federal income tax purposes were as
follows:
Aggregate cost ................................. $ 494,967
=========
Gross unrealized appreciation .................. $ 20,680
Gross unrealized depreciation .................. (489)
---------
Net unrealized appreciation .................... $ 20,191
=========
(a) AMBAC Insured.
(b) FGIC Insured.
(c) XL Capital Insured.
(d) FSA Insured.
(e) Assured Guaranty Insured.
(f) MBIA Insured.
(g) Prerefunded.
(h) Escrowed to maturity.
(i) Radian Insured.
(j) The rate disclosed is that currently in effect. This rate changes
periodically and inversely based upon prevailing market rates.
(k) CIFG Insured.
(l) Investments in companies considered to be an affiliate of the Fund, for
purposes of Section 2(a)(3) of the Investment Company Act of 1940, were as
follows:
--------------------------------------------------------------------------
Net Dividend
Affiliate Activity Income
--------------------------------------------------------------------------
Merrill Lynch Institutional
Tax-Exempt Fund (692) $55
--------------------------------------------------------------------------
(m) Represents a zero coupon or step bond; the interest rate shown reflects
the effective yield at the time of purchase.
(n) Represents the current yield as of July 31, 2006.
o Forward interest rate swaps outstanding as of July 31, 2006 were as
follows:
-------------------------------------------------------------------------
Notional Unrealized
Amount Depreciation
-------------------------------------------------------------------------
Pay a fixed rate of 4.168% and receive
a floating rate based on a 1-week Bond
Market Association rate
Broker, JPMorgan Chase Bank
Expires August 2016 $35,000 $ (419)
Pay a fixed rate of 4.285% and receive
a floating rate based on a 1-week Bond
Market Association rate
Broker, JPMorgan Chase Bank
Expires September 2021 $12,500 (134)
-------------------------------------------------------------------------
Total $ (553)
======
See Notes to Financial Statements.
10 MUNIENHANCED FUND, INC. JULY 31, 2006
Statement of Net Assets
As of July 31, 2006
===================================================================================================================================
Assets
-----------------------------------------------------------------------------------------------------------------------------------
Investments in unaffiliated securities, at value
(identified cost--$493,504,934) ............................................. $ 513,645,823
Investments in affiliated securities, at value
(identified cost--$1,512,632) ............................................... 1,512,632
Cash ......................................................................... 17,921
Receivables:
Securities sold ........................................................... $ 7,766,636
Interest .................................................................. 5,275,707 13,042,343
-------------
Prepaid expenses ............................................................. 9,127
-------------
Total assets ................................................................. 528,227,846
-------------
===================================================================================================================================
Liabilities
-----------------------------------------------------------------------------------------------------------------------------------
Unrealized depreciation on forward interest rate swaps ....................... 553,120
Payables:
Securities purchased ...................................................... 7,022,264
Investment adviser ........................................................ 204,767
Dividends to Common Stock shareholders .................................... 130,772
Other affiliates .......................................................... 3,500 7,361,303
-------------
Accrued expenses ............................................................. 51,385
-------------
Total liabilities ............................................................ 7,965,808
-------------
===================================================================================================================================
Preferred Stock
-----------------------------------------------------------------------------------------------------------------------------------
Preferred Stock, at redemption value, par value $.025 (2,000
Series A Shares, 2,000 Series B Shares, 2,000 Series C Shares) and
$.10 per share (1,480 Series D Shares) of AMPS* authorized, issued
and outstanding at $25,000 per share liquidation preference ................. 187,148,726
-------------
===================================================================================================================================
Net Assets Applicable to Common Stock
-----------------------------------------------------------------------------------------------------------------------------------
Net assets applicable to Common Stock ........................................ $ 333,113,312
=============
===================================================================================================================================
Analysis of Net Assets Applicable to Common Stock
-----------------------------------------------------------------------------------------------------------------------------------
Common Stock, par value $.10 per share (29,369,874 shares issued and
outstanding) ................................................................ $ 2,936,987
Paid-in capital in excess of par ............................................. 322,587,682
Undistributed investment income--net ......................................... $ 1,429,911
Accumulated realized capital losses--net ..................................... (13,429,037)
Unrealized appreciation--net ................................................. 19,587,769
-------------
Total accumulated earnings--net .............................................. 7,588,643
-------------
Total--Equivalent to $11.34 net asset value per share of Common
Stock (market price--$10.66) ................................................ $ 333,113,312
=============
* Auction Market Preferred Stock.
See Notes to Financial Statements.
MUNIENHANCED FUND, INC. JULY 31, 2006 11
Statement of Operations
For the Six Months Ended July 31, 2006
===================================================================================================================================
Investment Income
-----------------------------------------------------------------------------------------------------------------------------------
Interest and amortization of premium and discount earned ..................... $ 12,807,125
Dividends from affiliates .................................................... 54,624
-------------
Total income ................................................................. 12,861,749
-------------
===================================================================================================================================
Expenses
-----------------------------------------------------------------------------------------------------------------------------------
Investment advisory fees ..................................................... $ 1,293,275
Commission fees .............................................................. 234,217
Accounting services .......................................................... 88,515
Transfer agent fees .......................................................... 53,042
Professional fees ............................................................ 27,807
Printing and shareholder reports ............................................. 22,106
Custodian fees ............................................................... 15,971
Directors' fees and expenses ................................................. 12,155
Pricing fees ................................................................. 11,104
Listing fees ................................................................. 8,956
Other ........................................................................ 31,527
-------------
Total expenses before reimbursement .......................................... 1,798,675
Reimbursement of expenses .................................................... (3,370)
-------------
Total expenses after reimbursement ........................................... 1,795,305
-------------
Investment income--net ....................................................... 11,066,444
-------------
===================================================================================================================================
Realized & Unrealized Gain (Loss)--Net
-----------------------------------------------------------------------------------------------------------------------------------
Realized gain on:
Investments--net .......................................................... 1,006,927
Forward interest rate swaps--net .......................................... 575,499 1,582,426
-------------
Change in unrealized appreciation/depreciation on:
Investments--net .......................................................... (6,028,270)
Forward interest rate swaps--net .......................................... (132,220) (6,160,490)
----------------------------------
Total realized and unrealized loss--net ...................................... (4,578,064)
-------------
===================================================================================================================================
Dividends to Preferred Stock Shareholders
-----------------------------------------------------------------------------------------------------------------------------------
Investment income--net ....................................................... (3,072,868)
-------------
Net Increase in Net Assets Resulting from Operations ......................... $ 3,415,512
=============
See Notes to Financial Statements.
12 MUNIENHANCED FUND, INC. JULY 31, 2006
Statements of Changes in Net Assets
For the Six For the
Months Ended Year Ended
July 31, January 31,
Increase (Decrease) in Net Assets: 2006 2006
===================================================================================================================================
Operations
-----------------------------------------------------------------------------------------------------------------------------------
Investment income--net ....................................................... $ 11,066,444 $ 22,716,458
Realized gain--net ........................................................... 1,582,426 2,424,315
Change in unrealized appreciation/depreciation--net .......................... (6,160,490) (8,920,714)
Dividends to Preferred Stock shareholders .................................... (3,072,868) (4,591,787)
----------------------------------
Net increase in net assets resulting from operations ......................... 3,415,512 11,628,272
----------------------------------
===================================================================================================================================
Dividends to Common Stock Shareholders
-----------------------------------------------------------------------------------------------------------------------------------
Investment income--net ....................................................... (8,752,222) (21,205,049)
----------------------------------
Net decrease in net assets resulting from dividends to Common Stock
shareholders ................................................................ (8,752,222) (21,205,049)
----------------------------------
===================================================================================================================================
Net Assets Applicable to Common Stock
-----------------------------------------------------------------------------------------------------------------------------------
Total decrease in net assets applicable to Common Stock ...................... (5,336,710) (9,576,777)
Beginning of period .......................................................... 338,450,022 348,026,799
----------------------------------
End of period* ............................................................... $ 333,113,312 $ 338,450,022
==================================
* Undistributed investment income--net .................................... $ 1,429,911 $ 2,188,557
==================================
See Notes to Financial Statements.
MUNIENHANCED FUND, INC. JULY 31, 2006 13
Financial Highlights
For the Six
Months Ended For the Year Ended January 31,
The following per share data and ratios have been derived July 31, -----------------------------------------------------
from information provided in the financial statements. 2006 2006 2005 2004 2003
==================================================================================================================================
Per Share Operating Performance
----------------------------------------------------------------------------------------------------------------------------------
Net asset value, beginning of period ............... $ 11.52 $ 11.85 $ 11.83 $ 11.65 $ 11.43
---------------------------------------------------------------------
Investment income--net**** ......................... .38 .77 .79 .81 .83
Realized and unrealized gain (loss)--net ........... (.16) (.22) .05 .15 .17
Less dividends to Preferred Stock shareholders
from investment income--net ...................... (.10) (.16) (.07) (.06) (.08)
---------------------------------------------------------------------
Total from investment operations ................... .12 .39 .77 .90 .92
---------------------------------------------------------------------
Less dividends to Common Stock shareholders
from investment income--net ...................... (.30) (.72) (.73) (.72) (.70)
Offering and underwriting costs resulting from
the issuance of Preferred Stock .................. -- -- (.02) -- --
---------------------------------------------------------------------
Net asset value, end of period ..................... $ 11.34 $ 11.52 $ 11.85 $ 11.83 $ 11.65
=====================================================================
Market price per share, end of period .............. $ 10.66 $ 11.03 $ 10.93 $ 11.22 $ 10.62
=====================================================================
==================================================================================================================================
Total Investment Return**
----------------------------------------------------------------------------------------------------------------------------------
Based on net asset value per share ................. 1.19%+ 3.63% 7.20% 8.46% 8.62%
=====================================================================
Based on market price per share .................... (.65%)+ 7.58% 4.25% 12.84% 2.43%
=====================================================================
==================================================================================================================================
Ratios Based on Average Net Assets of Common Stock
----------------------------------------------------------------------------------------------------------------------------------
Total expenses, net of reimbursement*** ............ 1.08%* 1.07% 1.01% .97% 1.00%
=====================================================================
Total expenses*** .................................. 1.08%* 1.07% 1.01% .97% 1.00%
=====================================================================
Total investment income--net*** .................... 6.67%* 6.63% 6.80% 6.95% 7.17%
=====================================================================
Amount of dividends to Preferred Stock shareholders 1.85%* 1.34% .59% .48% .70%
=====================================================================
Investment income--net, to Common Stock shareholders 4.82%* 5.29% 6.21% 6.47% 6.47%
=====================================================================
==================================================================================================================================
Ratios Based on Average Net Assets of Preferred Stock
----------------------------------------------------------------------------------------------------------------------------------
Dividends to Preferred Stock shareholders .......... 3.31%* 2.46% 1.22% 1.09% 1.57%
=====================================================================
==================================================================================================================================
Supplemental Data
----------------------------------------------------------------------------------------------------------------------------------
Net assets applicable to Common Stock, end of period
(in thousands) ................................... $333,113 $338,450 $348,027 $347,389 $342,014
=====================================================================
Preferred Stock outstanding, end of period
(in thousands) ................................... $187,000 $187,000 $187,000 $150,000 $150,000
=====================================================================
Portfolio turnover ................................. 19.43% 27.72% 40.17% 50.47% 31.35%
=====================================================================
==================================================================================================================================
Leverage
----------------------------------------------------------------------------------------------------------------------------------
Asset coverage per $1,000 .......................... $ 2,781 $ 2,810 $ 2,861 $ 3,316 $ 3,280
=====================================================================
==================================================================================================================================
Dividends Per Share on Preferred Stock Outstanding
----------------------------------------------------------------------------------------------------------------------------------
Series A--Investment income--net ................... $ 404 $ 603 $ 309 $ 233 $ 350
=====================================================================
Series B--Investment income--net ................... $ 416 $ 629 $ 289 $ 354 $ 510
=====================================================================
Series C--Investment income--net ................... $ 412 $ 610 $ 295 $ 227 $ 327
=====================================================================
Series D--Investment income--net ................... $ 411 $ 614 $ 156 -- --
=====================================================================
* Annualized.
** Total investment returns based on market value, which can be significantly
greater or lesser than the net asset value, may result in substantially
different returns. Total investment returns exclude the effects of sales
charges.
*** Do not reflect the effect of dividends to Preferred Stock shareholders.
**** Based on average shares outstanding.
+ Aggregate total investment return.
See Notes to Financial Statements.
14 MUNIENHANCED FUND, INC. JULY 31, 2006
Notes to Financial Statements
1. Significant Accounting Policies:
MuniEnhanced Fund, Inc. (the "Fund") is registered under the Investment Company
Act of 1940, as amended, as a non-diversified, closed-end management investment
company. The Fund's financial statements are prepared in conformity with U.S.
generally accepted accounting principles, which may require the use of
management accruals and estimates. Actual results may differ from these
estimates. These unaudited financial statements reflect all adjustments, which
are, in the opinion of management, necessary to present a fair statement of the
results for the interim period. All such adjustments are of a normal, recurring
nature. The Fund determines and makes available for publication the net asset
value of its Common Stock on a daily basis. The Fund's Common Stock shares are
listed on the New York Stock Exchange under the symbol MEN. The following is a
summary of significant accounting policies followed by the Fund.
(a) Valuation of investments -- Municipal bonds are traded primarily in the
over-the-counter ("OTC") markets and are valued at the last available bid price
in the OTC market or on the basis of values as obtained by a pricing service.
Pricing services use valuation matrixes that incorporate both dealer-supplied
valuations and valuation models. The procedures of the pricing service and its
valuations are reviewed by the officers of the Fund under the general direction
of the Board of Directors. Such valuations and procedures are reviewed
periodically by the Board of Directors of the Fund. Financial futures contracts
and options thereon, which are traded on exchanges, are valued at their closing
prices as of the close of such exchanges. Options written or purchased are
valued at the last sale price in the case of exchange-traded options. In the
case of options traded in the OTC market, valuation is the last asked price
(options written) or the last bid price (options purchased). Swap agreements are
valued by quoted fair valuations received daily by the Fund's pricing service.
Short-term investments with a remaining maturity of 60 days or less are valued
at amortized cost, which approximates market value, under which method the
investment is valued at cost and any premium or discount is amortized on a
straight line basis to maturity. Investments in open-end investment companies
are valued at their net asset value each business day. Securities and other
assets for which market quotations are not readily available are valued at fair
value as determined in good faith by or under the direction of the Board of
Directors of the Fund. Such valuations and procedures will be reviewed
periodically by the Board of Directors of the Fund.
(b) Derivative financial instruments -- The Fund may engage in various portfolio
investment strategies both to increase the return of the Fund and to hedge, or
protect, its exposure to interest rate movements and movements in the securities
markets. Losses may arise due to changes in the value of the contract or if the
counterparty does not perform under the contract.
o Financial futures contracts -- The Fund may purchase or sell financial
futures contracts and options on such futures contracts. Financial futures
contracts are contracts for delayed delivery of securities at a specific
future date and at a specific price or yield. Upon entering into a
contract, the Fund deposits and maintains as collateral such initial
margin as required by the exchange on which the transaction is effected.
Pursuant to the contract, the Fund agrees to receive from or pay to the
broker an amount of cash equal to the daily fluctuation in value of the
contract. Such receipts or payments are known as variation margin and are
recorded by the Fund as unrealized gains or losses. When the contract is
closed, the Fund records a realized gain or loss equal to the difference
between the value of the contract at the time it was opened and the value
at the time it was closed.
o Options -- The Fund may write covered call options and purchase call and
put options. When the Fund writes an option, an amount equal to the
premium received by the Fund is reflected as an asset and an equivalent
liability. The amount of the liability is subsequently marked-to-market
reflecting the current market value of the option written. When a security
is purchased or sold through an exercise of an option, the related premium
paid (or received) is added to (or deducted from) the basis of the
security acquired or deducted from (or added to) the proceeds of the
security sold. When an option expires (or the Fund enters into a closing
transaction), the Fund realizes a gain or loss on the option to the extent
of the premiums received or paid (or gain or loss to the extent the cost
of the closing transaction exceeds the premium paid or received).
Written and purchased options are non-income producing investments.
o Swaps -- The Fund may enter into swap agreements, which are OTC contracts
in which the Fund and a counterparty agree to make periodic net payments
on a specified notional amount. The net payments can be made for a set
period of time or may be triggered by a predetermined credit event. The
net periodic payments may be based on a fixed or variable interest rate;
the change in market value of a specified security, basket of
MUNIENHANCED FUND, INC. JULY 31, 2006 15
Notes to Financial Statements (continued)
securities, or index; or the return generated by a security. These
periodic payments received or made by the Fund are recorded in the
accompanying Statement of Operations as realized gains or losses,
respectively. Gains or losses are also realized upon termination of the
swap agreements. Swaps are marked-to-market daily and changes in value are
recorded as unrealized appreciation (depreciation). Risks include changes
in the returns of the underlying instruments, failure of the
counterparties to perform under the contracts' terms and the possible lack
of liquidity with respect to the swap agreements.
(c) Income taxes -- It is the Fund's policy to comply with the requirements of
the Internal Revenue Code applicable to regulated investment companies and to
distribute substantially all of its taxable income to its shareholders.
Therefore, no federal income tax provision is required.
(d) Security transactions and investment income -- Security transactions are
recorded on the dates the transactions are entered into (the trade dates).
Realized gains and losses on security transactions are determined on the
identified cost basis. Dividend income is recorded on the ex-dividend dates.
Interest income is recognized on the accrual basis. The Fund amortizes all
premiums and discounts on debt securities.
(e) Dividends and distributions -- Dividends from net investment income are
declared and paid monthly. Distributions of capital gains are recorded on the
ex-dividend dates.
(f) Recent accounting pronouncement -- In July 2006, the Financial Accounting
Standards Board ("FASB") issued Interpretation No. 48 ("FIN 48") entitled
"Accounting for Uncertainty in Income Taxes -- an interpretation of FASB
Statement No. 109." FIN 48 prescribes the minimum recognition threshold a tax
position must meet in connection with accounting for uncertainties in income tax
positions taken or expected to be taken by an entity including mutual funds
before being measured and recognized in the financial statements. FIN 48 is
effective for fiscal years beginning after December 15, 2006. The Fund will
adopt FIN 48 during the fiscal 2008 year and the impact on the Fund's financial
statements, if any, is currently being assessed.
2. Investment Advisory Agreement and Transactions with Affiliates:
The Fund has entered into an Investment Advisory Agreement with Fund Asset
Management, L.P. ("FAM"). The general partner of FAM is Princeton Services, Inc.
("PSI"), an indirect, wholly-owned subsidiary of Merrill Lynch & Co., Inc. ("ML
& Co."), which is the limited partner.
FAM is responsible for the management of the Fund's portfolio and provides the
necessary personnel, facilities, equipment and certain other services necessary
to the operations of the Fund. For such services, the Fund pays a monthly fee at
an annual rate of .50% of the Fund's average daily net assets, including assets
acquired from the issuance of Preferred Stock. The Investment Adviser agreed to
reimburse its management fee by the amount of management fees the Fund pays to
FAM indirectly through its investment in Merrill Lynch Institutional Tax-Exempt
Fund. For the six months ended July 31, 2006, FAM reimbursed the Fund in the
amount of $3,370.
For the six months ended July 31, 2006, the Fund reimbursed FAM $5,418 for
certain accounting services.
Certain officers and/or directors of the Fund are officers and/or directors of
FAM, PSI, and/or ML & Co.
In February 2006, ML & Co. and BlackRock, Inc. entered into an agreement to
contribute ML & Co.'s investment management business, including FAM, to the
investment management business of BlackRock, Inc. The transaction is expected to
close around the end of the third quarter of 2006.
On August 15, 2006, shareholders of the Fund approved a new Investment Advisory
Agreement with BlackRock Advisors, Inc., a subsidiary of BlackRock, Inc., as
well as a contingent sub-advisory agreement with BlackRock Advisors, Inc. The
new advisory agreement will become effective upon the closing of the BlackRock
transaction described above and the investment advisory fee will be unchanged.
3. Investments:
Purchases and sales of investments, excluding short-term securities, for the six
months ended July 31, 2006 were $100,145,914 and $102,061,506, respectively.
4. Stock Transactions:
The Fund is authorized to issue 200,000,000 shares of stock, par value $.10 per
share, all of which were initially classified as Common Stock. The Board of
Directors is authorized, however, to reclassify any unissued shares of stock
without the approval of the holders of Common Stock.
Preferred Stock
Auction Market Preferred Stock are redeemable shares of Preferred Stock of the
Fund, with a liquidation preference of $25,000 per share plus accrued and unpaid
dividends that entitle their holders to receive cash dividends at an annual rate
that may vary for the successive dividend periods. The yields in
16 MUNIENHANCED FUND, INC. JULY 31, 2006
Notes to Financial Statements (concluded)
effect at July 31, 2006 were as follows: Series A, 3.44%; Series B, 3.60%;
Series C, 3.55%; and Series D, 3.50%.
The Fund pays commissions to certain broker-dealers at the end of each auction
at an annual rate ranging from .25% to .50%, calculated on the proceeds of each
auction. For the six months ended July 31, 2006, Merrill Lynch, Pierce, Fenner &
Smith Incorporated, an affiliate of FAM, received $123,013 as commissions.
5. Capital Loss Carryfoward:
On January 31, 2006, the Fund had a net capital loss carryforward of
$14,205,719, of which $3,380,202 expires in 2008, $8,505,599 expires in 2009,
$1,955,204 expires in 2011 and $364,714 expires in 2013. This amount will be
available to offset like amounts of any future taxable gains.
6. Subsequent Event:
The Fund paid a tax-exempt income dividend to holders of Common Stock in the
amount of $.047000 on August 30, 2006 to shareholders of record on August 14,
2006.
Disclosure of New Investment Advisory Agreement
New BlackRock Investment Advisory Agreement -- Matters Considered by the Board
In connection with the Transaction between Merrill Lynch and BlackRock, the
Fund's Board of Directors considered a new investment advisory agreement (the
"New Investment Advisory Agreement") between the Fund and BlackRock Advisors,
Inc. or its successor ("BlackRock Advisors"). The New Investment Advisory
Agreement has been approved by the Fund's shareholders and is expected to become
effective upon the closing of the Transaction in the third quarter of 2006.
The Board discussed the New Investment Advisory Agreement at telephonic and
in-person meetings held during April and May 2006. The Board, including the
independent directors, approved the New Investment Advisory Agreement at a
meeting held on May 9, 2006.
To assist the Board in its consideration of the New Investment Advisory
Agreement, BlackRock provided materials and information about BlackRock,
including its financial condition and asset management capabilities and
organization, and Merrill Lynch provided materials and information about the
Transaction. The independent directors, through their independent legal counsel,
also requested and received additional information from Merrill Lynch and
BlackRock in connection with their consideration of the New Investment Advisory
Agreement. The additional information was provided in advance of the May 9, 2006
meeting. In addition, the independent directors consulted with their counsel and
Fund counsel on numerous occasions, discussing, among other things, the legal
standards and certain other considerations relevant to the directors'
deliberations.
At the Board meetings, the directors discussed with Merrill Lynch management and
certain BlackRock representatives the Transaction, its strategic rationale and
BlackRock's general plans and intentions regarding the Fund. At these Board
meetings, representatives of Merrill Lynch and BlackRock made presentations to
and responded to questions from the Board. The directors also inquired about the
plans for and anticipated roles and responsibilities of certain employees and
officers of the Investment Adviser and certain affiliates being transferred to
BlackRock in connection with the Transaction. The independent directors of the
Board also conferred separately and with their counsel about the Transaction and
other matters related to the Transaction on a number of occasions, including in
connection with the April and May 2006 meetings. After the presentations and
after reviewing the written materials provided, the independent directors met in
executive sessions with their counsel to consider the New Investment Advisory
Agreement.
In connection with the Board's review of the New Investment Advisory Agreement,
Merrill Lynch and/or BlackRock advised the directors about a variety of matters.
The advice included the following, among other matters:
o that there is not expected to be any diminution in the nature, quality and
extent of services provided to the Fund and its shareholders by BlackRock
Advisors, including compliance services;
o that operation of New BlackRock as an independent investment management
firm will enhance its ability to attract and retain talented
professionals;
MUNIENHANCED FUND, INC. JULY 31, 2006 17
Disclosure of New Investment Advisory Agreement (continued)
o that the Fund should benefit from having access to BlackRock's state of
the art technology and risk management analytic tools, including
investment tools, provided under the BlackRock Solutions(R) brand name;
o that BlackRock has no present intention to alter any applicable expense
waivers or reimbursements currently in effect and, while it reserves the
right to do so in the future, it would seek the approval of the Board
before making any changes;
o that in connection with the Transaction, Merrill Lynch and BlackRock have
agreed to conduct, and use reasonable best efforts to cause their
respective affiliates to conduct, their respective businesses in
compliance with the conditions of Section 15(f) of the Investment Company
Act of 1940 (the "1940 Act") in relation to any public funds advised by
BlackRock or the Investment Adviser (or its affiliates), respectively; and
o that Merrill Lynch and BlackRock would derive benefits from the
Transaction and that, as a result, they have a different financial
interest in the matters that were being considered than do Fund
shareholders.
The directors considered the information provided by Merrill Lynch and BlackRock
above, and, among other factors, the following:
o the potential benefits to Fund shareholders from being part of a combined
fund family with BlackRock-sponsored funds, including possible economies
of scale and access to investment opportunities;
o the reputation, financial strength and resources of BlackRock and its
investment advisory subsidiaries and the anticipated financial strength
and resources of New BlackRock;
o the compliance policies and procedures of BlackRock Advisors;
o the terms and conditions of the New Investment Advisory Agreement,
including the fact that the schedule of the Fund's total advisory fees
will not increase by virtue of the New Investment Advisory Agreement, but
will remain the same;
o that in August 2005, the Board performed a full annual review of the
investment advisory agreement currently in effect for the Fund (the
"Current Investment Advisory Agreement") as required by the 1940 Act and
has determined that the Investment Adviser has the capabilities, resources
and personnel necessary to provide the advisory and administrative
services currently provided to the Fund; and that the advisory and/or
management fees paid by the Fund, taking into account any applicable
agreed-upon fee waivers and breakpoints, represent reasonable compensation
to the Investment Adviser in light of the services provided, the costs to
the Investment Adviser of providing those services, economies of scale,
the fees and other expenses paid by similar funds (including information
provided by Lipper Inc. ["Lipper"]), and such other matters as the
directors have considered relevant in the exercise of their reasonable
judgment; and
o that Merrill Lynch agreed to pay all expenses of the Fund in connection
with the Board's consideration of the New Investment Advisory Agreement
and related agreements and all costs of shareholder approval of the New
Investment Advisory Agreement and as a result the Fund would bear no costs
in obtaining shareholder approval of the New Investment Advisory
Agreement.
Certain of these considerations are discussed in more detail below.
In its review of the New Investment Advisory Agreement, the Board assessed the
nature, scope and quality of the services to be provided to the Fund by the
personnel of BlackRock Advisors and its affiliates, including administrative
services, shareholder services, oversight of fund accounting and assistance in
meeting legal and regulatory requirements. In its review of the New Investment
Advisory Agreement, the Board also considered a range of information in
connection with its oversight of the services to be provided by BlackRock
Advisors and its affiliates. Among the matters considered were: (a) fees (in
addition to management fees) to be paid to BlackRock Advisors and its affiliates
by the Fund; (b) Fund operating expenses paid to third parties; (c) the
resources devoted to and compliance reports relating to the Fund's investment
objective, policies and restrictions, and its compliance with its Code of Ethics
and BlackRock Advisors' compliance policies and procedures; and (d) the nature,
cost and character of non-investment management services to be provided by
BlackRock Advisors and its affiliates.
In the period prior to the Board meetings to consider renewal of the Current
Investment Advisory Agreement, the Board had requested and received materials
specifically relating to the Current Investment Advisory Agreement. These
materials included (a) information compiled by Lipper on the fees and
18 MUNIENHANCED FUND, INC. JULY 31, 2006
expenses and the investment performance of the Fund as compared to a comparable
group of funds as classified by Lipper; (b) information comparing the Fund's
market price with its net asset value per share; (c) a discussion by the Fund's
portfolio management team on investment strategies used by the Fund during its
most recent fiscal year; (d) information on the profitability to the Investment
Adviser of the Current Investment Advisory Agreement and other payments received
by the Investment Adviser and its affiliates from the Fund; and (e) information
provided by the Investment Adviser concerning services related to the valuation
and pricing of Fund portfolio holdings, the Fund's portfolio turnover
statistics, and direct and indirect benefits to the Investment Adviser and its
affiliates from their relationship with the Fund.
In their deliberations, the directors considered information received in
connection with their most recent continuation of the Current Investment
Advisory Agreement, in addition to information provided by BlackRock and
BlackRock Advisors in connection with their evaluation of the terms and
conditions of the New Investment Advisory Agreement. The directors did not
identify any particular information that was all-important or controlling. The
directors, including a majority of the independent directors, concluded that the
terms of the New Investment Advisory Agreement are appropriate, that the fees to
be paid are reasonable in light of the services to be provided to the Fund, and
that the New Investment Advisory Agreement should be approved and recommended to
Fund shareholders.
Nature, Quality and Extent of Services Provided -- The Board reviewed the
nature, extent and quality of services provided by the Investment Adviser,
including the investment advisory services and the resulting performance of the
Fund, as well as the nature, quality and extent of services expected to be
provided by BlackRock Advisors. The Board focused primarily on the Investment
Adviser's advisory services and the Fund's investment performance, but also
considered certain areas in which both the Investment Adviser and the Fund
receive services as part of the Merrill Lynch complex. The Board compared the
Fund's performance -- both including and excluding the effects of fees and
expenses -- to the performance of a comparable group of funds, and the
performance of a relevant index or combination of indexes. While the Board
reviews performance data at least quarterly, consistent with the Investment
Adviser's investment goals, the Board attaches more importance to performance
over relatively long periods of time, typically three to five years.
In evaluating the nature, quality and extent of the services to be provided by
BlackRock Advisors under the New Investment Advisory Agreement, the directors
considered, among other things, the expected impact of the Transaction on the
operations, facilities, organization and personnel of New BlackRock and how it
would affect the Fund; the ability of BlackRock Advisors to perform its duties
after the Transaction; and any anticipated changes to the current investment and
other practices of the Fund.
The directors were given information with respect to the potential benefits to
the Fund and its shareholders from having access to BlackRock's state of the art
technology and risk management analytic tools, including the investment tools
provided under the BlackRock Solutions brand name.
The directors were advised that, as a result of Merrill Lynch's equity interest
in BlackRock after the Transaction, the Fund will continue to be subject to
restrictions concerning certain transactions involving Merrill Lynch affiliates
(for example, transactions with a Merrill Lynch broker-dealer acting as
principal) absent revised or new regulatory relief. The directors were advised
that a revision of existing regulatory relief with respect to these restrictions
was being sought from the Securities and Exchange Commission and were advised of
the possibility of receipt of such revised regulatory relief. There can be no
assurance that such relief will be obtained.
Based on their review of the materials provided and the assurances they had
received from the management of Merrill Lynch and of BlackRock, the directors
determined that the nature and quality of services to be provided to the Fund
under the New Investment Advisory Agreement were expected to be as good as or
better than that provided under the Current Investment Advisory Agreement. It
was noted, however, that it is expected that there will be changes in personnel
following the Transaction and the combination of the operations of the
Investment Adviser and its affiliates with those of BlackRock. The directors
noted that if current portfolio managers or other personnel cease to be
available, the Board would consider all available options, which could include
seeking the investment advisory or other services of BlackRock affiliates.
Accordingly, the directors concluded that, overall, they were satisfied at the
present time with assurances from BlackRock and BlackRock Advisors as to the
expected nature, extent and quality of the services to be provided to the Fund
under the New Investment Advisory Agreement.
MUNIENHANCED FUND, INC. JULY 31, 2006 19
Disclosure of New Investment Advisory Agreement (concluded)
Costs of Services Provided and Profitability -- It was noted that, in
conjunction with the recent review of the Current Investment Advisory Agreement,
the directors had received, among other things, a report from Lipper comparing
the Fund's fees, expenses and performance to those of a peer group selected by
Lipper, and information as to the fees charged by the Investment Adviser or its
affiliates to other registered investment company clients for investment
management services. The Board reviewed the Fund's contractual management fee
rate and actual management fee rate as a percentage of total assets at common
asset levels -- the actual rate includes advisory fees and the effects of any
fee waivers -- compared to the other funds in its Lipper category. They also
compared the Fund's total expenses to those of other comparable funds. The
information showed that the Fund had fees and expenses within the range of fees
and expenses of comparable funds. The Board considered the services to be
provided by and the fees to be charged by BlackRock Advisors to other funds with
similar investment mandates and noted that the fees charged by BlackRock
Advisors in those cases, including fee waivers and expense reimbursements, were
generally comparable to those being charged to the Fund. The Board concluded
that the Fund's management fee and fee rate and overall expense ratio are
reasonable compared to those of other comparable funds.
In evaluating the costs of the services to be provided by BlackRock Advisors
under the New Investment Advisory Agreement, the directors considered, among
other things, whether advisory fees or other expenses would change as a result
of the Transaction. Based on their review of the materials provided and the fact
that the New Investment Advisory Agreement is substantially similar to the
Current Investment Advisory Agreement in all material respects, including the
rate of compensation, the directors determined that the Transaction should not
increase the total fees payable, including any fee waivers, or after any expense
caps or expense reimbursements, for advisory and administrative services. The
directors noted that it was not possible to predict how the Transaction would
affect BlackRock Advisors' profitability from its relationship with the Fund.
The directors discussed with BlackRock Advisors its general methodology to be
used in determining its profitability with respect to its relationship with the
Fund and noted that they expect to receive profitability information from
BlackRock Advisors on at least an annual basis.
Fees and Economies of Scale -- The Board considered the extent to which
economies of scale might be realized as the assets of the Fund increase and
whether there should be changes in the management fee rate or structure in order
to enable the Fund to participate in these economies of scale. The Board
considered economies of scale to the extent applicable to the Fund's closed-end
structure and determined that the Fund currently appropriately benefits from any
economies of scale and no changes were currently necessary.
In reviewing the Transaction, the directors considered, among other things,
whether advisory fees or other expenses would change as a result of the
Transaction. Based on the fact that the New Investment Advisory Agreement is
substantially similar to the Current Investment Advisory Agreement in all
material respects, including the rate of compensation, the directors determined
that as a result of the Transaction, the Fund's total advisory fees would be no
higher than the fees under its Current Investment Advisory Agreement. The
directors concluded that, because the rates for advisory fees for the Fund would
be no higher than its current fee rates, the proposed management fee structure,
including any fee waivers, was reasonable and that no additional changes were
currently necessary.
Fall-Out Benefits -- The directors considered whether the Fund would generate
any fall-out benefits to BlackRock Advisors. Fall-out benefits are indirect
profits from other activities that accrue to the adviser or its affiliates
solely because of the existence of the Fund. In evaluating the fall-out benefits
to be received by BlackRock Advisors under the New Investment Advisory
Agreement, the directors considered whether the Transaction would have an impact
on the fall out benefits received by the Investment Adviser by virtue of the
Current Investment Advisory Agreement. Based on their review of the materials
provided, including materials received in connection with their most recent
approval or continuance of the Current Investment Advisory Agreement, and their
discussions with management of the Investment Adviser and BlackRock, the
directors determined that those benefits could include increased ability for
BlackRock to distribute shares of its funds and other investment products. The
directors noted that any such benefits were difficult to quantify with certainty
at this time, and indicated that they would continue to evaluate them going
forward.
Investment Performance -- The directors considered investment performance for
the Fund. The directors compared the Fund's performance -- both including and
excluding the effects of fees and expenses -- to the performance of a comparable
group of funds, and the performance of a relevant index or combination of
indexes. The comparative informa-
20 MUNIENHANCED FUND, INC. JULY 31, 2006
tion received from Lipper showed Fund performance at various levels within the
range of performance of comparable funds over different time periods. The
directors believed the Fund's performance was satisfactory. Also, the directors
took into account the investment performance of funds currently advised by
BlackRock Advisors. The Board considered comparative information from Lipper
which showed that the performance of the funds advised by BlackRock Advisors was
within the range of performance of comparable funds over different time periods.
The Board noted BlackRock's considerable investment management experience and
capabilities, but was unable to predict what effect, if any, consummation of the
Transaction would have on the future performance of the Fund.
Conclusion -- After the independent directors of the Fund deliberated in
executive session, the entire Board, including the independent directors,
approved the New Investment Advisory Agreement, concluding that the advisory fee
rate was reasonable in relation to the services provided and that the New
Investment Advisory Agreement was in the best interests of the shareholders. In
approving the New Investment Advisory Agreement, the Board noted that it
anticipated reviewing the continuance of the agreement in advance of the
expiration of the initial two-year period.
Contingent BlackRock Subadvisory Agreement -- Matters Considered by the Board
At the telephonic and in-person meetings held during April and May 2006 at which
the Board of Directors discussed and approved the New Investment Advisory
Agreement, the Board, including the independent directors, also discussed and
approved a contingent subadvisory agreement (the "Contingent Subadvisory
Agreement") between the Investment Adviser and BlackRock Advisors (the
"BlackRock Subadviser"). The Contingent Subadvisory Agreement is intended to
ensure that the Fund operates with efficient portfolio management services until
the closing of the Transaction, in the event that the Board deems it necessary
and in the best interests of the Fund and its shareholders that the BlackRock
Subadviser assist in managing the operations of the Fund during the interim
period until the closing of the Transaction. The Contingent Subadvisory
Agreement would take effect only upon recommendation from the Investment Adviser
and upon subsequent approval of the Board in the period up to the closing of the
Transaction. The effectiveness of the Contingent Subadvisory Agreement,
therefore, is contingent on further Board approval. Pursuant to the Contingent
Subadvisory Agreement, the BlackRock Subadviser would receive a monthly fee from
the Investment Adviser equal to 50% of the advisory fee received by the
Investment Adviser. The Investment Adviser would pay the BlackRock Subadviser
out of its own resources. There would be no increase in Fund expenses as a
result of the Contingent Subadvisory Agreement.
In making its approval at the May in-person meeting, the Board considered the
Contingent Subadvisory Agreement in conjunction with the New Investment Advisory
Agreement and reviewed the same information and factors discussed above, and
came to the same conclusions. The Board also considered in conjunction with the
Contingent Subadvisory Agreement the necessity of ensuring that the Fund
operates with effective management services until the closing of the
Transaction. In reviewing the subadvisory fee rate provided in the Contingent
Subadvisory Agreement, the Board took note of the fact that both the Investment
Adviser and the BlackRock Subadviser would have significant responsibilities
under their respective advisory agreements. The Investment Adviser would remain
responsible for oversight of the Fund's operations and administration and the
BlackRock Subadviser would provide advisory services to the Fund under the
Contingent Subadvisory Agreement. The Board also took into account the expected
short duration of the term of any Contingent Subadvisory Agreement and the fact
that total advisory fees paid by the Fund would not increase as a result of the
Contingent Subadvisory Agreement. Under all of the circumstances, the Board
concluded that it was a reasonable allocation of fees for the BlackRock
Subadviser to receive 50% of the advisory fee paid by the Fund to the Investment
Adviser.
After the independent directors deliberated in executive session, the entire
Board, including the independent directors, approved the Contingent Subadvisory
Agreement, concluding that the advisory fee was reasonable in relation to the
services provided and that the Contingent Subadvisory Agreement was in the best
interests of shareholders.
MUNIENHANCED FUND, INC. JULY 31, 2006 21
Proxy Results
During the six-month period ended July 31, 2006, MuniEnhanced Fund, Inc.'s
Common Stock shareholders voted on the following proposal. The proposal was
approved at a shareholders' meeting on April 27, 2006. A description of the
proposal and number of shares voted are as follows:
------------------------------------------------------------------------------------------
Shares Voted Shares Withheld
For From Voting
------------------------------------------------------------------------------------------
1. To elect the Fund's Directors: Robert C. Doll, Jr. 27,641,388 542,548
James H. Bodurtha 27,600,201 583,735
Kenneth A. Froot 27,581,980 601,956
Joe Grills 27,624,026 559,910
Roberta Cooper Ramo 27,632,315 551,622
------------------------------------------------------------------------------------------
During the six-month period ended July 31, 2006, MuniEnhanced Fund, Inc.'s
Preferred Stock shareholders (Series A - D) voted on the following proposal. The
proposal was approved at a shareholders' meeting on April 27, 2006. A
description of the proposal and number of shares voted are as follows:
----------------------------------------------------------------------------------------------------------
Shares Voted Shares Withheld
For From Voting
----------------------------------------------------------------------------------------------------------
1. To elect the Fund's Board of Directors: Robert C. Doll, Jr.,
James H. Bodurtha, Kenneth A. Froot, Joe Grills,
Herbert I. London, Roberta Cooper Ramo and Robert S. Salomon, Jr. 6,826 588
----------------------------------------------------------------------------------------------------------
Officers and Directors
Robert C. Doll, Jr., President and Director
James H. Bodurtha, Director
Kenneth A. Froot, Director
Joe Grills, Director
Herbert I. London, Director
Roberta Cooper Ramo, Director
Robert S. Salomon, Jr., Director
Donald C. Burke, Vice President and Treasurer
Kenneth A. Jacob, Senior Vice President
John M. Loffredo, Senior Vice President
Michael A. Kalinoski, Vice President
Jeffrey Hiller, Chief Compliance Officer
Alice A. Pellegrino, Secretary
Custodian
State Street Bank and Trust Company
P.O. Box 351
Boston, MA 02101
Transfer Agents
Common Stock:
Computershare Trust Company, N.A.
P.O. Box 43010
Providence, RI 02940-3010
800-426-5523
Preferred Stock:
The Bank of New York
101 Barclay Street -- 7 West
New York, NY 10286
NYSE Symbol
MEN
22 MUNIENHANCED FUND, INC. JULY 31, 2006
Availability of Quarterly Schedule of Investments
The Fund files its complete schedule of portfolio holdings with the Securities
and Exchange Commission ("SEC") for the first and third quarters of each fiscal
year on Form N-Q. The Fund's Forms N-Q are available on the SEC's Web site at
http://www.sec.gov. The Fund's Forms N-Q may also be reviewed and copied at the
SEC's Public Reference Room in Washington, DC. Information on the operation of
the Public Reference Room may be obtained by calling 1-800-SEC-0330.
Electronic Delivery
The Fund offers electronic delivery of communications to its shareholders. In
order to receive this service, you must register your account and provide us
with e-mail information. To sign up for this service, simply access this Web
site at http://www.icsdelivery.com/live and follow the instructions. When you
visit this site, you will obtain a personal identification number (PIN). You
will need this PIN should you wish to update your e-mail address, choose to
discontinue this service and/or make any other changes to the service. This
service is not available for certain retirement accounts at this time.
MUNIENHANCED FUND, INC. JULY 31, 2006 23
[LOGO] Merrill Lynch Investment Managers
www.mlim.ml.com
--------------------------------------------------------------------------------
Mercury Advisors
A Division of Merrill Lynch Investment Managers
www.mercury.ml.com
MuniEnhanced Fund, Inc. seeks to provide shareholders with as high a level of
current income exempt from federal income taxes as is consistent with its
investment policies by investing primarily in a portfolio of long-term,
investment grade municipal obligations, the interest on which is exempt from
federal income taxes in the opinion of the bond counsel to the issuer.
This report, including the financial information herein, is transmitted to
shareholders of MuniEnhanced Fund, Inc. for their information. It is not a
prospectus. Past performance results shown in this report should not be
considered a representation of future performance. The Fund has leveraged its
Common Stock and intends to remain leveraged by issuing Preferred Stock to
provide the Common Stock shareholders with a potentially higher rate of return.
Leverage creates risks for Common Stock shareholders, including the likelihood
of greater volatility of net asset value and market price of shares of the
Common Stock, and the risk that fluctuations in the short-term dividend rates of
the Preferred Stock may affect the yield to Common Stock shareholders.
Statements and other information herein are as dated and are subject to change.
A description of the policies and procedures that the Fund uses to determine how
to vote proxies relating to portfolio securities is available (1) without
charge, upon request, by calling toll-free 1-800-637-3863; (2) at
www.mutualfunds.ml.com; and (3) on the Securities and Exchange Commission's Web
site at http://www.sec.gov. Information about how the Fund voted proxies
relating to securities held in the Fund's portfolio during the most recent
12-month period ended June 30 is available (1) at www.mutualfunds.ml.com and (2)
on the Securities and Exchange Commission's Web site at http://www.sec.gov.
MuniEnhanced Fund, Inc.
Box 9011
Princeton, NJ 08543-9011
#10874 -- 7/06
Item 2 - Code of Ethics - Not Applicable to this semi-annual report
Item 3 - Audit Committee Financial Expert - Not Applicable to this semi-annual
report
Item 4 - Principal Accountant Fees and Services - Not Applicable to this
semi-annual report
Item 5 - Audit Committee of Listed Registrants - Not Applicable to this
semi-annual report
Item 6 - Schedule of Investments - Not Applicable
Item 7 - Disclosure of Proxy Voting Policies and Procedures for Closed-End
Management Investment Companies - Not Applicable to this semi-annual
report
Item 8 - Portfolio Managers of Closed-End Management Investment Companies - Not
Applicable to this semi-annual report
Item 9 - Purchases of Equity Securities by Closed-End Management Investment
Company and Affiliated Purchasers - Not Applicable
Item 10 - Submission of Matters to a Vote of Security Holders - Not Applicable
Item 11 - Controls and Procedures
11(a) - The registrant's certifying officers have reasonably designed such
disclosure controls and procedures to ensure material information
relating to the registrant is made known to us by others particularly
during the period in which this report is being prepared. The
registrant's certifying officers have determined that the registrant's
disclosure controls and procedures are effective based on our evaluation
of these controls and procedures as of a date within 90 days prior to
the filing date of this report.
11(b) - There were no changes in the registrant's internal control over
financial reporting (as defined in Rule 30a-3(d) under the Act (17 CFR
270.30a-3(d)) that occurred during the last fiscal half-year of the
period covered by this report that has materially affected, or is
reasonably likely to materially affect, the registrant's internal
control over financial reporting.
Item 12 - Exhibits attached hereto
12(a)(1) - Code of Ethics - Not Applicable to this semi-annual report
12(a)(2) - Certifications - Attached hereto
12(a)(3) - Not Applicable
12(b) - Certifications - Attached hereto
Pursuant to the requirements of the Securities Exchange Act of 1934 and the
Investment Company Act of 1940, the registrant has duly caused this report to be
signed on its behalf by the undersigned, thereunto duly authorized.
MuniEnhanced Fund, Inc.
By: /s/ Robert C. Doll, Jr.
-------------------------------
Robert C. Doll, Jr.,
Chief Executive Officer of
MuniEnhanced Fund, Inc.
Date: September 20, 2006
Pursuant to the requirements of the Securities Exchange Act of 1934 and the
Investment Company Act of 1940, this report has been signed below by the
following persons on behalf of the registrant and in the capacities and on the
dates indicated.
By: /s/ Robert C. Doll, Jr.
-------------------------------
Robert C. Doll, Jr.,
Chief Executive Officer of
MuniEnhanced Fund, Inc.
Date: September 20, 2006
By: /s/ Donald C. Burke
-------------------------------
Donald C. Burke,
Chief Financial Officer of
MuniEnhanced Fund, Inc.
Date: September 20, 2006