NEW YORK–(BUSINESS WIRE)–Fitch Ratings has assigned a ‘AAA/F1’ rating to the following Series 6
Variable Rate Demand Preferred Shares (VRDP Shares) issued by Nuveen
California AMT-Free Municipal Income Fund (NKX):
–$105,000,000 of VRDP Shares, Series 6, final mandatory redemption on
June 1, 2046. The liquidity provider is Sumitomo Mitsui Banking
Corporation (rated ‘A’, Outlook Negative/’F1′ by Fitch).
In addition, Fitch has affirmed the long- and short-term ratings for the
following preferred shares issued by NKX:
–$35,500,000 of VRDP Shares, Series 2, final mandatory redemption on
June 1, 2040, at ‘AAA/F1’. The liquidity provider is Deutsche Bank Trust
Company Americas (‘A-/F1’);
–$42,700,000 of VRDP Shares, Series 3, final mandatory redemption on
March 1, 2040, at ‘AAA/F1+’. The liquidity provider is The
Toronto-Dominion Bank (‘AA-/F1+’);
–$109,000,000 of VRDP Shares, Series 4, final mandatory redemption on
Dec. 1, 2040, at ‘AAA/F1’. The liquidity provider is Citibank, N.A.
–$104,400,000 of VRDP Shares, Series 5, final mandatory redemption on
June 1, 2041, at ‘AAA/F1+’. The liquidity provider is Toronto-Dominion
–$36,000,000 of aggregate liquidation preference of Institutional
MuniFund Term Preferred Shares (iMTP Shares), series 2018, term
redemption on July 1, 2018 at ‘AAA’.
NKX is managed by Nuveen Fund Advisors, LLC (NFA) and subadvised by
Nuveen Asset Management, LLC (NAM).
KEY RATING DRIVERS
The long-term ratings primarily reflect:
–Sufficient asset coverage provided to the preferred shares as
calculated per the over-collateralization (OC) tests of NKX;
–The structural protections afforded by mandatory de-leveraging
provisions in the event of asset coverage declines;
–The legal and regulatory parameters that govern the fund’s operations.
The short-term ratings primarily reflect:
–The credit strength of the liquidity provider for each series of VRDP
–The terms and conditions of the VRDP Shares purchase agreements.
Both the short- and long-term ratings reflect the capabilities of NFA as
investment advisor and NAM as subadvisor.
NKX is a closed-end management investment company regulated by the
Investment Company Act of 1940 (the Act). The fund invests in municipal
securities that are exempt from regular federal income tax, AMT tax and
California State income tax. The fund may invest up to 20% of assets in
below investment-grade and/or unrated securities judged by NFA to be of
comparable quality. As of May 31, 2016, NKX’s total investment exposure
(i.e. total assets under management including assets purchased using
leverage) was about $1.2 billion.
NKX’s total leverage on May 31, 2016 consisted of about $328 million of
preferred shares and about $41 million of tender option bonds (TOBs) and
effective leverage was about 32%. Total leverage as of May 31, 2016 does
not include the $105 million of newly issued Series 6 VRDP Shares, which
is the primary reason effective leverage for the fund has increased from
its May 31, 2016 level to about 38%.
As of today’s date including the impact of the new issuance, the fund’s
asset coverage ratio, as calculated in accordance with the Act, is in
excess of the minimum asset coverage threshold of 225% required by the
fund’s governing documents.
As of today’s date including the impact of the new issuance, the fund’s
effective leverage ratio is below the 45% maximum effective leverage
ratio allowed by the governing documents of the preferred shares issued
by the fund.
PREFERRED SHARE STRUCTURAL PROTECTIONS
In the event of asset coverage declines, the fund’s governing documents
require the fund to reduce leverage in order to restore compliance with
the applicable asset coverage test.
Minimum Asset Coverage compliance is tested daily for the iMTP Shares
and monthly for the VRDP Shares. Compliance with the Effective Leverage
Ratio is tested daily for all preferred shares.
For VRDP and iMTP Shares, failure to cure a breach of the Minimum Asset
Coverage requirement by the allotted cure date results in mandatory
redemption of sufficient preferred shares to restore compliance. To
facilitate redemption, the fund will deposit sufficient funds with a
third-party tender/redemption and paying agent. The time allowed for the
fund to restore compliance is consistent with Fitch’s 60 business day
For the iMTP Shares, a breach of the Effective Leverage Ratio threshold
requires the fund to redeem a sufficient number of preferred shares,
and/or reduce the amount of TOBs the fund has outstanding in order to
restore compliance. The time allowed for the fund to restore compliance
is consistent with Fitch’s 60 business day criteria guideline.
The governing documents of the VRDP Shares do not require mandatory
deleveraging in the event of a breach of the Effective Leverage Ratio.
Rather, the documents state that a breach of the Effective Leverage
Ratio is a breach of the fee agreement with the applicable liquidity
provider and at the option of the applicable liquidity provider, may
result in mandatory tender of VRDP Shares of the applicable series for
remarketing (see the VRDP Purchase Obligation section below for
details). However, for as long as the iMTP shares are outstanding, the
fund is required to take such action to restore compliance in the event
of an Effective Leverage Ratio breach.
VRDP PURCHASE OBLIGATION
The short-term ratings assigned to the VRDP Shares of each series are
directly linked to the short-term creditworthiness of the associated
The Series 2, 3, 4 and 5 VRDP Shares are each supported by an applicable
purchase agreement to ensure full and timely repayment of all tendered
VRDP Shares of the applicable series plus any accumulated and unpaid
dividends. The Series 6 VRDP Shares are supported by a standby letter of
credit (LOC) and purchase agreement to ensure full and timely repayment
of all tendered Series 6 VRDP Shares. The purchase agreements in the
case of the Series 2-5 VRDP Shares, and the standby LOC and purchase
agreement in the case of the Series 6 VRDP Shares, are unconditional and
In the case of the Series 2-5 VRDP Shares, the applicable VRDP purchase
agreement requires the liquidity provider to purchase all VRDP Shares of
the applicable series tendered for sale that were not successfully
remarketed. The liquidity provider must also purchase all outstanding
VRDP Shares of the applicable series if the fund has not obtained an
alternate purchase agreement prior to the termination of the purchase
agreement being replaced or following the downgrade of the liquidity
provider’s short-term rating below ‘F2’ (or equivalent).
In the case of the Series 6 VRDP Shares, the standby LOC and purchase
agreement provides for a standby LOC issued by Sumitomo to the Tender
and Paying Agent for the account of and in favor of the Holders and/or
Beneficial Owners of the Series 6 VRDP Shares to fund the purchase of
VRDP Shares tendered for sale that were not successfully remarketed, or
to fund the purchase of all outstanding VRDP Shares if NKX has not
obtained a replacement liquidity provider prior to the termination of
the standby LOC and purchase agreement, or following the downgrade of
Sumitomo’s short-term rating below ‘F2’ (or equivalent).
The liquidity provider’s role under the fee agreement relating to the
purchase obligation (in the case of the Series 2-5 VRDP Shares) or the
funding and purchase obligation (in the case of the Series 6 VRDP
Shares) has a scheduled termination date. Prior to the scheduled
termination date, the fee agreement can be extended to a new scheduled
termination date, or a new liquidity provider may be selected. Any
future changes to the terms of the fee agreement that weakens the
structural protections discussed above may have negative rating
Fitch performed various stress tests on the fund in order to assess the
strength of the structural protections available to the preferred shares
compared to the stresses outlined in Fitch’s closed-end fund rating
criteria. These tests included determining various ‘worst case’
scenarios where the fund’s leverage and portfolio composition migrated
to the outer limits of its operating and investment guidelines.
Only under remote circumstances, such as increasing leverage to 45%
while simultaneously increasing issuer concentration and migrating the
portfolio to a mix of 80% long-term ‘BBB’ 10+ years to maturity bonds
and 20% high yield bonds, did the asset coverage available to the rated
preferred shares fall below the ‘AAA’ threshold and instead passed at an
‘AA’ rating level.
Given the highly unlikely nature of the stress scenarios and the minimal
rating impact, Fitch views the fund’s permitted investments, municipal
issuer diversification framework and mandatory deleveraging mechanisms
as consistent with a ‘AAA’ rating.
NFA, a subsidiary of Nuveen Investments, is the fund’s investment
advisor. NFA is responsible for the fund’s overall investment strategies
and their implementation. The sub-advisor, NAM, is a subsidiary of NFA
that oversees the day-to-day operations of the fund. Nuveen Investments
and its affiliates had approximately $230 billion of assets under
management as of March 31, 2016.
The ratings assigned to the preferred shares may be sensitive to
material changes in the leverage level or composition, portfolio credit
quality or market risk of the fund, as described above. A material
adverse deviation from Fitch guidelines for any key rating driver could
cause ratings to be lowered by Fitch.
For the VRDP Shares of each series, certain terms relevant to key VRDP
structural protections, including asset coverage and effective leverage
are set forth in the fee agreements relating to the purchase agreements
and are renewed on a periodic basis. Any future changes to terms that
weaken the structural protections may have negative rating implications.
The short-term ratings assigned to the VRDP Shares of each series may
also be sensitive to changes in the financial condition of the
applicable liquidity provider. A downgrade of the liquidity provider to
‘F2’ would result in a downgrade of the short-term ratings of the VRDP
Shares of the applicable series to ‘F2’, absent other mitigants. A
downgrade below ‘F2’, on the other hand, would not necessarily result in
a downgrade of the short-term rating of the VRDP Shares, given the
features in the transactions that would result in a mandatory tender of
the VRDP Shares for remarketing, or purchase by the applicable liquidity
provider in the event of a failed remarketing.
The fund has the ability to assume economic leverage through derivative
transactions which may not be captured by the Minimum Asset Coverage
Test or Effective Leverage Ratio. The fund does not currently engage in
speculative derivative activity and do not envision engaging in material
amounts of such activity in the future. In fact, such activity is
limited by the fund’s investment guidelines and could run counter to
their investment objective of achieving tax-exempt income. Material
derivative exposures in the future could have potential negative rating
implications if they adversely affect asset coverage available to rated
For additional information about Fitch’s rating guidelines applicable to
debt and preferred stock issued by closed-end funds, please review the
criteria referenced below, which can be found at ‘www.fitchratings.com‘.
Additional information is available at ‘www.fitchratings.com‘.
The sources of information used to assess this rating were the public
domain and Nuveen Fund Advisors.
Opt-in to receive Fitch’s forthcoming research on closed-end fund:
Rating Closed-End Funds and Market Value Structures (pub. 11 May 2016)
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