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Actionable news in NZF: Nuveen DIVIDEND ADVANTAGE Municipal FUND 3,

Nuveen Muni Funds Update- September 2016

Summary

The environment which we warned previously on several articles has played out producing lower earnings and coverage ratios.

Distributions will likely see cuts in some of the largest closed-end funds of the entire space.

It remains unclear how long the pressure will be on the funds but another 60 days appears possible.

This monthly Nuveen municipal closed-end fund UNII and earnings report is arguably the most anticipated and important in recent memory simply due to the fact that the market experienced some significant pain in the last 45 days. Discounts widened dramatically with coverage ratios falling. Most importantly, NAVs have rolled over significantly in conjunction with the iShares Municipal ETF (NYSEARCA:MUB) which hit its high in mid-July.

Interest rate fears are the main driver of the discount widening in the last few weeks. The Fed has essentially sent the market a memo stating their intention to raise rates this December. Sentiment has soured drastically since the middle of the year, very much like last year. On October 17th, despite interest rates falling back to the mid-1.7% area, these muni CEFs continued to sell off.

Muni's continue to underperform treasuries due to a large amount of supply that has come to the market. Couple that with a slowdown in fund flows (which we highlighted in our prior month's write up) means that rates will go up while prices fall. In a short period of time, muni CEFs gave up ALL of their year-to-date gains. Many of the holders of shares of muni CEFs are retail investors and tend to easily get spooked by higher rates. That accounts for the discount widening. But the lower NAVs are attributed to increased supply and higher interest rates generally with the ten-year rising to 1.80%, decreasing prices.

Below is a chart of the VanEck Vectors CEF Municipal ETF (NYSEARCA:XMPT) which is an ETF of muni CEFs:

(Source: Yahoo Finance)

Yields on new issues have plummeted with the MUB now generating an average yield of just 1.74%.

(Source: iShares)

There has been a spike in new municipal supply which totaled $323.4 billion in the first three quarters of 2016, a 7.4% rise yoy. The third quarter supply totaled $110 billion, a massive 18.4% increase from the year before. August and September were especially high in supply exceeding their historical averages. Clearly a large amount of supply has hit the market, and this week looks no different with a large $15.5 billion of new issues. That rate of supply, as municipalities take advantage of the low rates to call and refinance issues, is likely to continue through the fourth quarter.

However, we think once that bulge in supply passes close to year-end, and the fears of the interest rate hike subside...


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