NAD - NAD: Quality Municipal Bond CEF With High Leverage Usage

2023-11-23 09:00:00 ET

Summary

• Nuveen Quality Municipal Income Fund is a high-level leverage fund within Nuveen's National Investment-grade Municipal Bond CEFs.
• NAD aims to provide current income exempt from federal income tax and enhance portfolio value by investing in undervalued municipal securities.
• NAD recently increased its monthly payout from $.38 to $.44 after four previous cuts, and its ability to maintain the payout depends on various factors.
• If interest rates have peaked, NAD benefits in multiple ways which are discussed.  My current rating is a Buy.

Introduction

Nuveen has six National Investment-grade Municipal Bond CEFs which can be subgrouped by the level of leverage each CEF employs. Here, I will review the Nuveen Quality Muni Income Fund ( NAD ), one of the two high-level leveraged funds. The Nuveen AMT-Free Quality Muni Inc ( NEA ) is the other and I reviewed it recently ( article link ).

Along with discussing NAD's current features, I will discuss why I gave this CEF a Buy rating as it relates to interest rates, quality of the holdings and the purchase discount currently available to investors.

Nuveen Quality Municipal Income Fund review

Seeking Alpha describes this CEF as:

The investment objective of the fund is to provide current income exempt from regular federal income tax and to enhance portfolio value relative to the municipal bond market by investing in tax-exempt municipal securities that the Fund's investment adviser believes are underrated or undervalued or that represent municipal market sectors that are undervalued. It seeks to invest in investment-grade securities with an average maturity of around 18 years. The CEF started in 1999.

Source: seekingalpha.com NAD

Being a CEF, the capital structure differs from ETFs and CEFs without leverage, as shown next.

If you look at sites like Seeking Alpha, the first number, Common Net Assets, is what is normally presented. This structure also results in two sets of fee percents.

NAD had a leverage ratio of over 42% as of the end of October.

Holdings review

As will be noted later, NAD has a long duration of almost 18 years. While that is bad when rates climb, it is where bond investors want to be when rates fall. With the average non-zero bond selling for $93.42, there is price appreciation that can be achieved before the portfolio starts selling for more than Par. That is important as bonds approach maturity and the price moves toward their Par value.

If rates do peak in 2024, only 2.3% of the portfolio matures before 2025. While about 15% of the portfolio can be Called before 2025, current rates dim that possibility. Both factors limit the natural flow of bonds into today's higher coupon bonds.

Unlike other CEFs recently reviewed, Transportation bonds comprise the largest sector allocation, followed by Healthcare then bonds linked to tax collections.

At 27.5%, the two Tax Obligation sectors have a lower allocation than most funds I have reviewed. Since they are connected to the economic situation in each state, those allocations are as such:

The above list contains all states with 3+% in exposure, keeping in mind not all that allocation is from state-level issuers. That said, it is still comforting to see some of the stronger states with high allocations, like Texas and Colorado.

Top holdings

Even with just under 1200 positions, the Top 20 still account for 9+% of the portfolio. About 75% of the total weight is in the 423 largest positions, meaning the last 750 holdings are only 25% of the portfolio, which is not a bad spread.

Distributions review

After four cuts that started in 2022, NAD, as numerous other Nuveen municipal bond funds did, they increased their monthly payout, here from $.038 to $.044. This has the Forward Yield at 4.92%, based on price.

When setting and maintaining the payout level, some of the principles used by Nuveen to set them include:

• Each Fund intends to distribute all or substantially all of its net investment income through its regular monthly distribution and to distribute realized capital gains at least annually.
• In addition, in any monthly period, to maintain its declared distribution amount, each Fund may distribute more or less than its net investment income during the period. In the event a Fund distributes more than its net investment income during any yearly period, such distributions may also include realized gains and/or a return of capital.
• Each Fund's ability to maintain its declared distribution amount will depend on a number of factors; including the amount and stability of investment income earned by the Fund, underlying market conditions, and the Fund's expenses, including expenses associated with the Fund's use of leverage.

Important to setting the payout is the Distribution Coverage Ratio. Here is how the data has changed over the past year.

The average earnings per share and average UNII per share are estimates, using data from the last three months. With the new payout level, the coverage ratio drops to 82%.

Price and NAV review

Both the price and NAV have taken big hits since interest rates were pushed up to fight inflation with current levels for both approaching their COVID lows. The current discount of just under 14% is the deepest since the 2008-09 GFC.

While NAD has not sold at a premium very often, the discount was below 2% just before the recent FOMC actions on rates. A reverse in policy could result in the discount closing again.

Portfolio strategy

For investors in the upper tax brackets, owning municipal bonds might provide higher after-tax yields. The next table displays this.

The potential for a better after-tax yield is one reason I am bullish on this CEF and gave it a Buy rating. Others include:

• Recent inflation news could mean that "higher for longer" in terms of FOMC actions could be less so than just a month ago.
• Lower rates mean current bond prices would increase to meet the coupon yields from new offerings of the same maturity and rating.
• Lower rates also mean the cost of using leverage would decrease, which would be a big positive. Today's cost is 4.57%; last year, it was just 1.65%.
• When rates are declining, having a long duration like NAD should have a CEF like these outperforming ones with shorter durations.
• The current 14% discount is down from 16% recently. Early in 2023, it spiked below 8% indicating there is that added possible performance bump.

While researching NAD, one should ask if this is the best style to hold in the municipal bond CEF universe. Of course, that answer has differed depending on the time frame used. Here I compared NAD to NEA mentioned earlier and two other Nuveen CEFs.

• Nuveen Select Tax-Free Income Portfolio ( NXP ) which has no leverage.
• Nuveen Municipal High Income Opportunity Fund ( NMZ ) which invests in HY bonds.

The latest results show skipping leverage via NXP treated investors the best.

But if you go back to before the FOMC started pushing up interest rates, then the results look very different.

NXP trails the others here, with the NMZ on top in all time periods except for the last three months. If others also think we are near the peak in this rate cycle, this implies to me leveraged CEFs are the place to be. For those willing to take on more risk, then owning NMZ versus NAD is a viable choice, which I recently covered ( article link ).

Final thoughts

Who is minding the store? Nuveen announced that NAD is getting some new managers effective Oct 13, 2023: Stephen J. Candido and Michael S. Hamilton were added as portfolio managers of the Fund. The current manager, Christopher L. Drahn, will retire from Nuveen next April but will serve as portfolio manager until that time. Both of the new managers have been with Nuveen for years and manage other municipal bond funds.

Investors in states like California and New York, plus others, with high state income taxes need to compare their single-state fund against how NAD has done. I have several state-level articles on Seeking Alpha to check out for those investors.

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