NZF - NZF: Very Erratic Payouts Explained

2023-06-12 10:00:00 ET

Summary

• The Nuveen Municipal Credit Income Fund invests in undervalued municipal securities and other related investments exempt from regular federal income taxes.
• The fund seeks to invest in investment-grade securities rated Baa/BBB or better with an average maturity of around 18 years.
• The recent erratic movements in NZF prompted a deeper analysis, covering holdings, distribution, price and NAV, and portfolio strategy.
• I give NZF a Hold rating as I favor funds that have moved down the credit ratings ladder as they seem to have already started their recovery.

(This article was co-produced with Hoya Capital Real Estate )

Introduction

In a comment to a recent municipal bond article, a reader asked my opinion on the Nuveen Municipal Credit Income Fund ( NZF ). This article's title came from what I saw when glancing at NZF to provide a response. The recent erratic movements had me deciding to look deeper; this is what I found. The Nuveen Ohio Quality Municipal Income Fund (XNUOX) and Nuveen Georgia Quality Municipal Income Fund (NKG) merged into NFZ on 4/3/23 as explained in this news release . This resulted in two payouts to holders of the merged CEFs from income that had yet to be distributed. Unfortunately, other factors must also come into play resulting in the regular monthly payouts to drop pre-merger.

Nuveen Municipal Credit Income Fund review

Seeking Alpha describes this CEF as:

The Nuveen Municipal Credit Income Fund invests in undervalued municipal securities and other related investments the income from which is exempt from regular federal income taxes. It seeks to invest in investment grade securities rated Baa/BBB or better with an average maturity of around 18 years. NZF started in 2001.

Source: seekingalpha.com NZF

NFZ has $2.61b in AUM with a current Forward Yield of 4.51%. Nuveen provides fees based on either Common or Total assets.

To show how much leveraging costs have changed, last October the common shares cost was 87bps less than now. Leverage is 39%.

Holdings review

Not sure when Nuveen posts the most recent monthly data; this is what is currently available.

One of the factors that differ between funds, even within the same family, is sector allocations.

Bonds backed by taxes account for at least 34% of the portfolio, which states they are from then becomes important. Transportation bonds, 18.9% of the portfolio, could be a concern if lockdowns or a recession occurs as toll income supporting those bonds would be hurt. Another COVID-like limitation imposed on hospitals would affect Health Care bonds, the largest sector in NZF.

The Top 11 states represent 75% of the portfolio.

Almost half the portfolio is in states with one of the highest taxes: income, sales, and property combined, which could make it hard to get more from those sources. All three states are also losing population, California for the first time since joining the union. It should be noted that not all of any state's allocation are state-issued debt. When looking at the portfolio by obligor, we see the states themselves are not a large part of the portfolio's obligations.

An important measure of risk is the credit quality of the portfolio, which I calculated to be A- overall.

Just over 11% would be classified as "junk"; with a not unusual 25% of the bonds not having a rating. The WAM for NZF is almost 19 years, with an effective duration just under 14 years.

With an WAC of 5.3% and current AA/A 20-yr municipals yielding less, it doesn't appear having 5% maturing soon will boost the fund's income stream.

Top holdings

NZF owns 10 issues from Energy Harbor Corporation, which file for bankruptcy and was recently purchased by Vistra Corp. Vistra will assume roughly $430 million in debt and offer a 15% ownership stake in Vistra Vision to Energy Harbor's two largest shareholders: Avenue Capital Group and Nuveen. With over 4% in Energy Harbor, how that settles out will have a big effect of NZF.

Distribution review

Ignoring the "make whole" payouts in 2023, NZF has dropped its monthly payout from $.066 to $.043 since early 2022, a 35% reduction in just over a year when interest rates were climbing. That is a clear demonstration of what using leverage does when rates are going up; absorption of income that could have gone to the CEF's investors. NZF shows a 100+% coverage ratio since late 2022 (at least), aided by the recent cuts in the payout amount. Currently, the ratio is over 105%.

Price and NAV review

While the above chart shows NZF selling at a discount most times, the next chart indicates the depth over time.

It was mid/late 2021 when NZF last traded at a premium. The 14.9% discount is the widest since breaking 20% during the 2008-09 GFC. I suspect the uncertainty around the Energy Harbor allocation could be playing a part here. A shrinkage to 5% seems reasonable based on past history. All three Z-scores are negative, which is good for buyers at this time.

Portfolio strategy

One question for potential investors to ask is ,"How does NZF compare to other CEFs of the same type?". To help with the question, I picked two other Nuveen CEFs, plus an ETF I recently covered.

• Nuveen AMT-Free Municipal Credit Income Fund ( NVG )
• Nuveen Municipal High Income Opportunity Fund ( NMZ )
• Vanguard Tax-Exempt Bond Index Fund ETF ( VTEB )

While VTEB has the smoother ride, it comes in last for CAGR. NVG and NZF are close in most values, with NMZ slightly behind. Dropping the ETF, this is how the income from each looks.

As one might expect, the High-Yield NMZ CEF generates the most income, with NZF placing first or second most years; even above NMZ. It should be also noted that the other Nuveen CEFs have also cut their payouts in 2023. That might continue unless they cut back on their use of leverage.

Final thoughts

While the returns over the past decade are meager, the total returns for all three CEFs still was ahead of what investment-grade corporate ETFs provided to investors, with that advantage expanding the more income taxes the investor paid.

According to data provided by Matisse Capital, the average muni CEF is trading at an 11% discount to its NAV. This compares to the long-term average of 4% and only a 1.5% discount at the beginning of 2022. While investors with low municipal bond allocation should consider NZF with is near 15% discount. I give NZF a Hold rating as I currently favor funds that have moved down the credit ratings ladder as they seem to have already started their recovery.

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