NEW YORK--(BUSINESS WIRE)--Fitch Ratings confirms the 'AAA/F1+' ratings assigned to the Series 2 Variable Rate Demand Preferred Shares (VRDP shares) issued by Nuveen Dividend Advantage Municipal Fund 2 (NXZ), a municipal closed-end fund (CEF). The fund is managed by Nuveen Fund Advisors, LLC (NFA) and subadvised by Nuveen Asset Management, LLC (NAM).
Fitch confirms the following ratings:
Nuveen Dividend Advantage Municipal Fund 2 (NXZ):
$196,000,000 of VRDP shares, Series 2, final mandatory redemption on June 1, 2040, confirmed at 'AAA/F1+'.
The confirmation is in connection with a substitution of the liquidity support provider to the VRDP shares, from Deutsche Bank Trust Company Americas (DBTCA: rated 'A+/F1+' by Fitch) to The Toronto-Dominion Bank ('TD': rated 'AA- / F1+'), which becomes effective at the close of business on Aug. 29, 2014. The terms of the new purchase agreement and fee agreement with TD dated as of Aug. 8, 2014 are substantially the same as the terms of the agreements that have been substituted. The short-term rating primarily reflects the credit strength of TD as to the VRDP shares. The long-term rating of the VRDP shares is not affected by the replacement of the liquidity provider and remains unchanged.
KEY RATING DRIVERS
The short-term rating primarily reflects:
--The credit strength of TD as liquidity provider to the VRDP shares;
--The terms and conditions of the VRDP shares purchase agreement.
The long-term rating primarily reflects:
--Sufficient asset coverage provided to the VRDP shares as calculated per the fund's over-collateralization (OC) tests;
--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;
--Both the short- and long-term ratings also reflect the capabilities of NFA as investment advisor and NAM as subadvisor.
The fund is a closed-end management investment company regulated by the Investment Company Act of 1940. The fund invests in municipal securities that are exempt from federal income taxes. The fund may invest up to 20% of its managed assets in municipal securities rated below investment grade and up to 10% of its managed assets may be rated below the 'B' rating category or are unrated and judged to be of comparable quality by NFA or NAM.
VRDP SHARE ASSET COVERAGE
As of July 31, 2014, the fund's asset coverage ratio for total outstanding VRDP shares, as calculated in accordance with the Investment Company Act of 1940, was in excess of the minimum asset coverage of 225% required by the fund's governing documents.
As of the same date, the fund's Effective Leverage Ratio of 34% was below the 45% maximum leverage ratio allowed by the fund's governing documents for the VRDP shares.
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 asset coverage test. For the VRDP shares, Minimum VRDP Asset Coverage compliance is tested monthly and compliance with the Effective Leverage Ratio is tested daily.
Failure to cure a breach of the Minimum VRDP Asset Coverage requirement by the allotted cure date results in mandatory preferred share redemption. The fund must redeem sufficient preferred shares to restore compliance. To facilitate redemption, the fund will deposit sufficient funds with a third-party tender and paying agent. The time allowed for the fund to restore compliance is consistent with Fitch's 60 business day criteria guideline.
For the VRDP shares, a breach of the Effective Leverage Ratio is a breach of the fee agreement with the liquidity provider and at the option of the liquidity provider, may result in mandatory tender of the VRDP shares for remarketing. However, in the event of a breach, Fitch expects the fund to take actions similar to those described above to restore compliance. The allotted time to restore compliance to the Effective Leverage Ratio is consistent with Fitch's 60 business day criteria guideline.
VRDP PURCHASE OBLIGATION
The short-term rating assigned to the VRDP shares is directly linked to TD's short-term creditworthiness.
The VRDP shares are supported by a purchase agreement to ensure full and timely repayment of all tendered VRDP shares plus any accumulated and unpaid dividends. The purchase agreement is unconditional and irrevocable.
The VRDP purchase agreement requires TD as the liquidity provider to purchase all VRDP shares tendered for sale that are not successfully remarketed. The liquidity provider must also purchase all outstanding VRDP shares 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 rating below 'F2' (or equivalent).
TD's role as liquidity provider under the fee agreement relating to the purchase obligation has a scheduled termination date. Prior to the scheduled termination date, the fee agreement can be extended to a new scheduled termination date with TD, or a new liquidity provider may be selected. Any future changes to the terms of the fee agreement with TD or a prospective replacement that weakens the structural protections discussed above may have negative rating implications.
Fitch performed various stress tests on the fund to assess the strength of the structural protections available to the VRDP shares compared to the rating 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 the fund's operating and investment guidelines.
Only under remote circumstances, such as increasing the fund's issuer concentration, while simultaneously migrating the portfolio to 80% 'BBB', 10+ years to maturity bonds and 20% high yield bonds, did the asset coverage available to the VRDP shares fall below the 'AAA' guideline, and instead passed at the 'AA' guideline.
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 an 'AAA' rating.
TIAA-CREF ACQUISITION AGREEMENT
TIAA-CREF has announced an agreement to acquire Nuveen Investments Inc. (Nuveen) for $6.25 billion, inclusive of Nuveen's outstanding debt. The boards of directors at both TIAA-CREF and Nuveen each have approved the transaction, which is expected to be complete by year-end 2014. The boards of directors and shareholders of Nuveen's closed-end funds also have to approve the transaction.
TIAA-CREF's planned acquisition of Nuveen will have minimal impact on Nuveen's closed-end fund business, which is reflected in the affirmation of all Fitch-rated Nuveen closed-end fund preferred securities.
THE FUND'S ADVISOR
The investment advisor is NFA, a subsidiary of Nuveen. 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 and its affiliates had approximately $224.6 billion of assets under management as of March 31, 2014.
The ratings assigned to the VRDP shares may be sensitive to material changes in the leverage 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 a ratings downgrade by Fitch.
Certain terms relevant to key VRDP structural protections, including the Minimum Asset Coverage and the Effective Leverage Ratio are set forth in the fee agreement relating to the purchase agreement and are renewed on a periodic basis. Any future changes to these terms that weaken the structural protections may have negative rating implications.
The short-term rating assigned to the VRDP shares may also be sensitive to changes in the financial condition of the liquidity provider. A downgrade of the liquidity provider to 'F2' would result in a downgrade of the short-term rating of the VRDP shares 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 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 fund's Minimum Asset Coverage test or Effective Leverage Ratio. The fund does not currently engage in derivative activities and does 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 the fund's 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 VRDP shares.
For additional information about Fitch rating guidelines applicable to debt and preferred stock issued by closed-end fund, please review the criteria referenced below, which can be found on Fitch's web site 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: http://pages.fitchemail.fitchratings.com/FAMCEFBlankOptin/
Applicable Criteria and Related Research:
--'Fitch: Minimal Impact on Nuveen CEFs from TIAA Acquisition' (April 15, 2014);
--'Rating Closed-End Fund Debt and Preferred Stock' (Aug. 14, 2013);
--'Global Rating Criteria for Asset-Backed Commercial Paper' (Nov. 8, 2012);
--'Municipal Closed-End Fund Diversify Funding and Moderate Rollover Risk' (Oct. 11, 2012);
--'Municipal CEFs Refinance Pre-Crisis ARPS' (May 3, 2012).
Applicable Criteria and Related Research:
Rating Closed-End Fund Debt and Preferred Stock
Global Rating Criteria for Asset-Backed Commercial Paper -- Effective November 8, 2012 to November 7, 2013
Municipal Closed-End Funds Diversify Funding and Moderate Rollover Risk
Municipal CEFs Refinance Pre-Crisis ARPS