Nuveen declared December distributions for their equity and fixed-income CEFs yesterday which included distribution cuts for many of their national and state specific municipal bond funds. Here is the release, Nuveen Distribution Declarations.
Though nobody likes to see distribution cuts, I would rather a fund sponsor be pro-active and get the cuts out of the way instead of letting funds linger with distributions they cannot cover. With what has been going on in the municipal bond sector over the past several months and particularly since interest rates have spiked up since the election, these cuts were hardly a surprise.
It's been a brutal last few months for municipal bond CEFs and we've just seen an acceleration of market price and NAV drops over the last couple of weeks that would rival anything we saw in 2013. Back then, a perfect storm of rising rates, a threat of municipal sector bankruptcies & defaults and talk of a cap on interest deductibility as part of a balanced budget proposal out of Washington, all contributed to bring down municipal bond prices to their lowest levels since the financial crisis of 2008.
Today, municipalities are in much better financial shape but that hasn't stopped the accelerated drop in municipal bond prices as the threat of rising interest rates has made this go around seem more real, especially with a looming Federal Reserve meeting which is widely expected to result in a rate increase. Still, as is often the case, reactions can be overdone and when bad news piles up like this, sometimes just getting the bad news out of the way can give relief.
Are We There Yet?
So will this latest news of the Nuveen distribution cuts be such an inflection point? Time will tell but certainly these distribution cuts for many of the funds was not unexpected. In fact, several of the largest Nuveen national muni bond CEFs had recently raised their distributions when mergers of other Nuveen muni funds into them were completed earlier this year.
One such fund, the Nuveen AMT-Free Quality Municipal Income Fund (NYSE:NEA), $13.03 market price, $14.12 NAV, -7.7% discount, 6.2% current market yield, created the largest municipal bond CEF of all at $5.7 billion in total assets managed and when the newly merged fund declared its first distribution a month ago for November at $0.068/share, up from $0.0625 previously, I think a lot of investors were surprised to see a distribution increase when the fund's UNII (Undistributed Net Investment Income) was already hovering at around break-even to negative.
So with this latest distribution cut, Nuveen has essentially taken back that increase and has brought NEA's distribution back down to $0.062/share, just slightly lower than its $0.0625/share before. And NEA is not the only Nuveen national muni bond fund that is really only taking back a recent distribution increase as a result of a merger completion.
Two other funds that also saw distribution cuts, the Nuveen Enhanced Municipal Credit Opportunities Fund (NYSEMKT:NZF), $13.80 market price, $14.84 NAV, -7.0% discount, 6.6% current market yield and the Nuveen Dividend Advantage Municipal Income Fund (NYSEMKT:NVG), $14.02 market price, $15.06 NAV, -6.9% discount, 6.5% current market yield, will continue to have distributions well above their former merger levels even with these latest cuts.
So the bottom line is that investors should not overreact to these cuts since many were already anticipated. For example, Morgan Stanley (NYSE:MS) initiated coverage of NEA just a few days ago and said this in their report...
We are initiating coverage of Nuveen AMT-Free Quality Municipal Income Fund with an Equal-weight rating. The leveraged national fund recently merged with three other Nuveen funds and is now the largest US-listed municipal bond CEF by market capitalization, at $3.5 billion. In addition to its enhanced liquidity versus most peers, the fund's favorable attributes include management by a deep and experienced municipal bond team at Nuveen, the absence of holdings subject to the alternative minimum tax (AMT), investment grade average credit quality and a relatively wide discount. Having set its post-merger dividend at a fairly high level, in part to assure that holders of all merged funds would initially receive at least the same monthly dollar amount as they did pre-merger, and following municipal CEF price declines, NEA currently offers a 6.1% annualized distribution rate.
We believe the fund's positive attributes are balanced by substantial interest rate sensitivity, as indicated by approximately a 12.1-year leverage-adjusted NAV duration, and the likelihood of an eventual significant dividend cut, given its aggressive post-merger payout level and one-year upcoming portfolio callability of 16.0%. As the product of a recent merger, and following an adjustment to its investment policies, the fund entails additional complications of which investors should be mindful. NEA is in the process of moving closer to new guidelines that permit up to 35% to be allocated to BBB or lower-rated bonds, in contrast to its former 20% limit.
Certainly, municipal bond CEFs involve substantial risk with their enhanced use of leverage, but at some point, you have to realize that these funds only own what are considered to be some of the safest and most tax advantaged investments available to investors, even the lower grade municipal bonds.
Many municipal bond CEFs are currently at 52-week to multi-year lows. The greatest unknown and the biggest weight on these funds is how high will interest rates go now that the Trump election seems to have given a green light to further rate increases by the Federal Reserve.
But I will leave you with this thought. Any hint of a peak in economic activity (due to rapidly rising rates) or any controversy or gridlock between President Trump and Congress, foreign Governments or any other entity that Wall Street fears could have negative implications for the global economy or global stability could see the markets make a rapid return to the safety of bonds.
Disclosure: I am/we are long NEA, NZF, NVG.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.