Fitch Takes Rating Actions on Nuveen Fund VRDP Shares Upon Liquidity Provider Replacement

NEW YORK--(BUSINESS WIRE)-- Fitch Ratings affirms the 'AAA' long-term rating and upgrades to 'F1+' from 'F1' the short-term rating of the $104,400,000 of Series 5 Variable Rate Demand Preferred Shares (VRDP Shares) issued by Nuveen California AMT-Free Municipal Income Fund (NKX). Fitch has removed the short-term rating of the Series 5 VRDP Shares from Rating Watch Positive.

In addition, the long- and short-term ratings of all other preferred shares issued by NKX are affirmed as follows:

--$35,500,000 of VRDP Shares, Series 2, final mandatory redemption on June 1, 2040, 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, at 'AAA/F1+'. The liquidity provider is The Toronto-Dominion Bank ('AA-/F1+');

--$109,000,000 of VRDP Shares, Series 4, final mandatory redemption on Dec. 1, 2040, at 'AAA/F1'. The liquidity provider is Citibank, N.A. ('A+/F1');

--$36,000,000 of aggregate liquidation preference of Institutional MuniFund Term Preferred Shares (iMTP Shares), series 2018, term redemption on July 1, 2018 at 'AAA'.

THE LIQUIDITY PROVIDER SUBSTITUION

The upgrade of the short-term rating for the Series 5 VRDP Shares is in connection with the substitution of the current liquidity provider, The Toronto-Dominion Bank (TD: 'AA-/F1+'), for the previous liquidity provider to the VRDP shares, Morgan Stanley Bank, N.A. (Morgan Stanley: 'A+/F1'). The short-term rating of the Series 5 VRDP Shares is now directly linked to the short-term rating of current liquidity provider TD.

The terms of the new purchase agreement and fee agreement with TD dated as of April 7, 2016 (effective as of the close of business on May 2, 2016) are substantially the same as the terms of the previous agreements with Morgan Stanley.

KEY RATING DRIVERS

The long-term ratings primarily reflect:

--Sufficient asset coverage provided to the preferred shares as calculated per the over-collateralization (OC) tests of NKX;

--The structural protections afforded by mandatory de-leveraging provisions in the event of asset coverage declines;

--The legal and regulatory parameters that govern the operations of NKX.

The short-term ratings primarily reflect:

--The credit strength of the liquidity provider for each series of VRDP Shares;

--The terms and conditions of the VRDP shares purchase agreements.

Both the short- and long-term ratings reflect the capabilities of NFA as investment advisor and NAM as subadvisor.

FUND PROFILE

NKX is a closed-end management investment company regulated by the Investment Company Act of 1940 (the Act) and managed by Nuveen Fund Advisors, LLC (NFA) and subadvised by Nuveen Asset Management, LLC (NAM).

The fund invests at least 80% of its managed assets in municipal securities that are exempt from regular federal income tax, AMT tax and California state income tax, and may invest up to 20% of assets in below investment-grade and/or unrated securities. As of March 31, 2016, NKX had approximately $1.1 billion in total investment exposure (i.e. total assets under management including assets purchased using leverage).

ASSET COVERAGE

As of March 31, 2016, NKX's asset coverage ratio for total outstanding preferred shares, as calculated in accordance with the Act, was in excess of the minimum asset coverage of 225% required by the fund's governing documents.

As of the same date, NKX's effective leverage ratios was 32%, which is below the 45% maximum leverage ratio allowed by the fund's governing documents for the VRDP Shares. As of March 31, 2016, NKX leverage was composed of $327.6 million of rated preferred shares and $41.1 million of tender option bonds (TOBs).

STRUCTURAL PROTECTIONS

In the event of asset coverage declines, NKX's governing documents require the fund to reduce leverage in order to restore compliance with the applicable asset coverage test.

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 the iMTP Shares and for the VRDP Shares.

For iMTP Shares and the VRDP Shares, failure to cure a breach of the Minimum Asset Coverage requirement by the allotted cure date results in mandatory redemption of sufficient preferred shares to restore compliance. To facilitate redemption, the fund will deposit sufficient funds with a third-party tender and paying agent. The time allowed for the funds to restore compliance is consistent with Fitch's 60 business day criteria guideline.

For iMTP Shares, a breach of the Effective Leverage Ratio threshold requires the fund to redeem a sufficient number of preferred shares, and / or reduce the amount of TOBs the fund has outstanding in order to restore compliance. The time allowed for the funds to restore compliance is consistent with Fitch's 60 business day criteria guideline.

For VRDP Shares, 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 for remarketing (see the 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 TOBs outstanding in order to restore compliance. The allotted time to restore compliance to the Effective Leverage Ratio test is consistent with Fitch's 60-business-day criteria guideline.

VRDP PURCHASE OBLIGATION

The short-term ratings assigned to the VRDP Shares of each series are directly linked to the short-term creditworthiness of the associated liquidity provider. The VRDP Shares are supported by a purchase agreement to ensure full and timely repayment of all tendered VRDP Shares 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 liquidity provider's role under the fee agreement relating to the purchase obligation for each series has a scheduled termination date. Prior to the scheduled termination date, the fee agreement can be extended to a new scheduled termination date, or a new liquidity provider may be selected. Any future changes to the terms of the fee agreement that weakens the structural protections discussed above may have negative rating implications.

STRESS TESTS

Fitch performed various stress tests on NKX to assess the strength of the structural protections available to the preferred shares compared to the rating stresses outlined in Fitch's closed-end fund rating criteria. These tests included determining various 'worst case' scenarios where NKX's leverage and portfolio composition migrated to the outer limits of its operating and investment guidelines.

For NKX, only under remote circumstances, such as increasing leverage to 45% while simultaneously increasing its issuer concentration and migrating the portfolios to 80% 'BBB', 10+ years to maturity bonds and 20% high yield bonds, did the asset coverage available to the preferred shares fall below the 'AAA' threshold, and instead passed at an 'AA' rating level.

Given the highly unlikely nature of the stress scenarios and the minimal rating impact, Fitch views NKX's permitted investments, municipal issuer diversification framework and mandatory deleveraging mechanisms as consistent with the present rating levels of the preferred shares.

THE ADVISORS

NFA, a subsidiary of Nuveen Investments, is the investment advisor for NKX. NFA is responsible for the fund's overall investment strategies and their implementation. NAM is a subsidiary of NFA and oversees the day-to-day operations of NKX.

Nuveen Investments and its affiliates had approximately $225 billion in assets under management as of Dec. 31, 2015.

RATING SENSITIVITIES

The ratings assigned to the preferred shares may be sensitive to material changes in the leverage level or 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 VRDP structural protections, including the Minimum Asset Coverage and the Effective Leverage Ratio are set forth in 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 rating assigned to the VRDP shares 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 rating of the VRDP shares 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 asset coverage test or effective leverage ratio. NKX does not currently engage in speculative derivative activities and does not envision engaging in material amounts of such activity in the future. In fact, such activity is limited by the fund's investment guidelines and could run counter to its investment objectives of achieving tax-exempt income.

Additional information is available on www.fitchratings.com.

The sources of information used to assess this rating were the public domain and Nuveen Fund Advisors.

Applicable Criteria

Rating Closed-End Fund Debt and Preferred Stock (pub. 16 Sep 2015)

https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=871119

Additional Disclosures

Dodd-Frank Rating Information Disclosure Form

https://www.fitchratings.com/creditdesk/press_releases/content/ridf_frame.cfm?pr_id=1003873

Solicitation Status

https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=1003873

Endorsement Policy

https://www.fitchratings.com/jsp/creditdesk/PolicyRegulation.faces?context=2&detail=31

ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: HTTP://FITCHRATINGS.COM/UNDERSTANDINGCREDITRATINGS. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEBSITE 'WWW.FITCHRATINGS.COM'. PUBLISHED RATINGS, CRITERIA AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. FITCH'S CODE OF CONDUCT, CONFIDENTIALITY, CONFLICTS OF INTEREST, AFFILIATE FIREWALL, COMPLIANCE AND OTHER RELEVANT POLICIES AND PROCEDURES ARE ALSO AVAILABLE FROM THE 'CODE OF CONDUCT' SECTION OF THIS SITE. FITCH MAY HAVE PROVIDED ANOTHER PERMISSIBLE SERVICE TO THE RATED ENTITY OR ITS RELATED THIRD PARTIES. DETAILS OF THIS SERVICE FOR RATINGS FOR WHICH THE LEAD ANALYST IS BASED IN AN EU-REGISTERED ENTITY CAN BE FOUND ON THE ENTITY SUMMARY PAGE FOR THIS ISSUER ON THE FITCH WEBSITE.

View source version on businesswire.com: http://www.businesswire.com/news/home/20160503007174/en/

Fitch Ratings
Primary Analyst
Ralph Aurora
Senior Director
+1-212-908-0528
Fitch Ratings, Inc.
33 Whitehall St.
New York, NY 10004
or
Secondary Analyst
Brian Knudsen
Associate Director
+1-646-582-4904
or
Committee Chairperson
Davie Rodriguez
Senior Director
+1-212-908-0386
or
Media Relations:
Hannah James, +1-646-582-4947
[email protected]

Source: Fitch Ratings

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