NEW YORK--(BUSINESS WIRE)--Fitch Ratings assigns an 'AAA' Long-term rating to the series 2018 Institutional MuniFund Term Preferred Shares (iMTP Shares) issued by Nuveen California AMT-Free Municipal Income Fund (NKX) in connection with the refinancing described below. Fitch also affirms the Short-term ratings and Long-term ratings for four existing series of Variable Rate Demand Preferred Shares (VRDP Shares) issued by NKX. NKX is managed by Nuveen Fund Advisors, LLC (NFA) and subadvised by Nuveen Asset Management, LLC (NAM).
Fitch takes the following rating actions on the series of preferred shares noted below:
--$36,000,000 of aggregate liquidation preference of iMTP Shares, series 2018, term redemption on July 1, 2018 rated 'AAA';
--$35,500,000 of VRDP Shares series 2, final mandatory redemption on June 1, 2040 affirmed 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 affirmed at 'AAA/F1+'. The liquidity provider is Deutsche Bank Trust Company Americas ('A+/F1+');
--$109,000,000 of VRDP Shares series 4, final mandatory redemption on Dec. 1, 2040 affirmed at 'AAA/F1'. The liquidity provider is Citibank, N.A. ('A/F1');
--$104,400,000 of VRDP Shares series 5, final mandatory redemption on June 1, 2041 affirmed at 'AAA/F1'. The liquidity provider is Morgan Stanley Bank, N.A. ('A/F1').
KEY RATING DRIVERS
The short-term ratings of the VRDP Shares primarily reflect:
--The credit strength of the liquidity providers for the NKX VRDP Shares;
--The terms and conditions of the purchase agreements of the VRDP Shares.
The 'AAA' long-term ratings of the iMTP Shares and VRDP Shares primarily reflect:
--Sufficient asset coverage provided to the iMTP Shares and VRDP Shares as calculated per the NKX 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 NKX operations.
--Both the short- and long-term ratings also reflect the capabilities of NFA as investment advisor and NAM as subadvisor.
NKX will use the proceeds of the iMTP Share issuance to fully redeem outstanding MuniFund Term Preferred Shares (MTP Shares). The proceeds of the newly issued iMTP Shares will be deposited irrevocably in an escrow account with the MTP Shares redemption agent pending the required 10-day notification period to MTP shareholders. Accordingly the issuance of new iMTP Shares will not adversely affect the ratings of the existing MTP Shares while they remain outstanding. The amount deposited with NKX's redemption agent will equal the liquidation preference of the MTP Shares and any accrued and unpaid dividends. When the notification requirement has passed, Fitch expects the outstanding MTP Shares to be redeemed using the escrowed iMTP Share proceeds, which will then be marked paid in full by Fitch.
NKX is a closed-end management investment company regulated by the Investment Company Act of 1940. NKX invests in municipal securities that are exempt from regular federal and California income taxes. NKX may invest up to 20% of assets in below investment grade and or unrated securities.
As of Nov. 28, 2014, NKX had approximately $1,139 million in assets. Total leverage on a pro forma basis, consists of $36 million of the newly issued Series 2018 iMTP shares, approximately $291.6 million of VRDP Shares and $71.9 million of tender option bond obligations.
As of Nov. 28, 2014, NKX's total pro forma asset coverage ratio for the above noted iMTP Shares and VRDP Shares, as calculated in accordance with the Investment Company Act of 1940, were in excess of the minimum asset coverage threshold of 225% currently set by the terms of the preferred shares.
As of Nov. 28, 2014, the pro forma effective leverage ratio for NKX, including the impact of the iMTP issuance, was 35%. This effective leverage ratio is below the 45% maximum effective leverage ratio allowed by the governing documents of the iMTP and VRDP Shares.
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 both iMTP Shares and for VRDP Shares. A breach of the asset coverage threshold requires NKX to redeem sufficient iMTP or VRDP Shares to restore compliance.
For the VRDP Shares of each applicable series, 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 VRDP Shares of the applicable series for remarketing (see VRDP Purchase Obligation section below for additional details). However, in the event of a breach, Fitch expects NKX to redeem a sufficient number of preferred shares or reduce the amount of tender option bonds (TOBs) in order to restore compliance.
For the asset coverage and effective leverage ratio tests, the total market value exposure periods (i.e. the pre-specified time period allotted for valuation, cure and redemption in the event of a breach) are within the 60 business day guidelines provided in Fitch's criteria.
VRDP PURCHASE OBLIGATION
The short-term rating assigned to each series of VRDP Shares is directly linked to the short-term creditworthiness of the applicable liquidity provider. The VRDP Shares of each series are supported by a purchase agreement to ensure full and timely repayment of all tendered VRDP Shares of the applicable series plus any accumulated and unpaid dividends. The purchase agreement is unconditional and irrevocable.
The 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 NKX 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).
The role of the liquidity provider under the fee agreement relating to the purchase obligation has a scheduled termination date. Subsequent to the scheduled termination date, the fee agreement can be extended with the existing liquidity provider, or a new liquidity provider may be selected. Any future changes to the terms of the fee agreements or any prospective replacement that weakens the structural protections discussed above may have negative rating implications.
Fitch performed various stress tests on NKX 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 NKX's leverage and portfolio composition migrated to the outer limits of its operating and investment guidelines.
Only under remote circumstances, such as increasing NKX's issuer concentration, while simultaneously migrating the portfolios 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 iMTP and VRDP shares fall below the 'AAA' threshold, and instead passed at a 'AA' rating level.
Given the highly unlikely nature of the stress scenarios, and the minimal rating impact, Fitch views the NKX's permitted investments, municipal issuer diversification framework and mandatory deleveraging mechanisms as consistent with an 'AAA' rating.
The investment advisor for NKX 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 NKX. Nuveen Investments and its affiliates had approximately $229 billion of assets under management as of Sept. 30, 2014.
The ratings assigned to the iMTP and VRDP shares may be sensitive to material changes in the leverage composition, portfolio credit quality or market risk of NKX, as described above. A material adverse deviation from Fitch guidelines for any key rating driver could cause ratings to be lowered by Fitch.
Certain terms relevant to key structural protections of the VRDP shares of each series, including the minimum asset coverage and the effective leverage ratio are set forth in the fee agreements relating to the purchase agreements 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 ratings assigned to the VRDP shares of each series 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 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 liquidity provider in the event of a failed remarketing.
NKX 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. NKX does not currently engage in derivative activity and does not envision engaging in material amounts of such activity in the future. In fact, such activity is limited by the investment guidelines of NKX and could run counter to its investment objectives of achieving tax-exempt income. Material derivative exposures in the future could have potential negative rating implications if it adversely affects asset coverage available to rated preferred shares.
For additional information about Fitch rating guidelines applicable to debt and preferred stock issued by closed-end funds, 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.
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Applicable Criteria and Related Research:
--'Rating Closed-End Fund Debt and Preferred Stock' (Sept. 4, 2014);
--'Global Rating Criteria for Asset-Backed Commercial Paper' (Oct. 30, 2014);
--'Leveraged Closed-End Funds Weather U.S. Rate Shock Scenarios' (Oct. 7, 2014);
--'Municipal CEFs Refinance Pre-Crisis ARPS' (May 3, 2012).
Applicable Criteria and Related Research:
Municipal CEFs Refinance Pre-Crisis ARPS
Rating Closed-End Fund Debt and Preferred Stock -- Effective August 14, 2013 to September 4, 2014
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