The auction rate issues are probably not a NAV issue but are instead a dividend issue. The liability amount will not change but the cost of the liability will move to the cap impacting dividend flows. Most closed ends seem to have a cap currently in the low 4% area. It does add some risk though as many of these trade to a yield level. I would further add that many municipalities are expected to term out the debt and hence LT yields may rise from here as supply hits. This move could further hit muni prices. I saw this coming a few days back, saw my one closed end fund not go down and did nothing. It then lost 7% on Thursday. Stupid me! Should have sold and SHORTED!
On the subject of leveraged muni bond funds and failed preferred auctions, there is an article in today's Times about the confusion in the market. The funds don't necessarily have to redeem the preferred, they can leave it out at the penalty rate. Given that the discount is twice or more in the leveraged funds, and that the leverage in the Nuveen funds is not that high (35% or so), the leveraged funds may not be a bad idea.
"In many cases, the penalty rates on those issues are less than 3.5 percent, a rate that is not attractive to buyers at the moment, given the risk that they might not be able to sell the security at a future auction. All 102 such auctions on Tuesday failed.
“That should cause the leveraged municipal bond funds to redeem their preferreds,” Mr. Gallatin, now retired, said Tuesday. He noted that at those penalty rates there was little benefit to common shareholders, and that preferred shareholders were suffering because the liquidity they expected was no longer there.
The fund companies no doubt will resist such redemptions, in part because it would cost them some management fees. But fund directors have fiduciary responsibilities to all holders, which could force them to consider redeeming the preferred securities. If they do, a quarter or more of bonds held in such funds would have to be sold."
There s a Morningstar article indicating that the maximum rate on some Nuveen preferred is 4.256%.
"Analyst Mariana Bush of Wachovia Securities, a unit of Wachovia Corp. (WB), described how this happened in what was probably the first such recent failure. Last week, the auction for Nuveen Premium Income Municipal Fund 4 (NPT), a fund with $570 million in net assets, failed. In the case of the Nuveen fund, its preferred-share rate rose to 110% of the higher of the taxable equivalent of the Kenny S&P 30-day High Grade Index or a AA composite commercial-paper rate, two yield indexes. The yield rose to 4.356% a year. That rate was 1.33 percentage points higher than rates on some other Nuveen fund preferred shares that didn't reset that day."
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