The impact of tax reform on the US municipal market

The US final tax reform bill that was signed into law in late December 2017 ultimately spared private activity bonds, which are important to the municipal bond market, but prohibited another important aspect — advance refundings. In addition, the new tax act included several elements that could affect the municipal market. In this commentary paper, Senior Portfolio Manager Greg Gizzi breaks down the various provisions of tax reform and what it can mean to municipal investors.

Read the paper

Videos: Dissecting tax reform for the municipal market

In a series of brief videos, Gizzi also discusses the effects of tax reform on the municipal bond market. In this first video, Munis and tax reform: Implications for individual investors, he explains various provisions — in particular, what it can mean for individual municipal bond investors in both the short and long term.

Gregory A. Gizzi

Senior Portfolio Manager

The tax act for individual investors was relatively benign. There are some short-term positive implications and some medium- or longer-term concerns that the market might have from an issuer’s perspective, and we could in fact see some structural changes to the marketplace. Let’s look at rates. The individual top tax rate falling from 39.6 to 37%, in our opinion, does not create a substantial change to taxable equivalent yields that could compromise demand from individuals.

Impacts of the SALT and mortgage cap deduction provisions

The SALT and the mortgage cap deduction does play a role in the marketplace, particularly in the short term. We feel as individual investors visit their accountants or do their taxes and recognize what those, losing those deductions, what that means for their individual tax status, there could be an increase in demand for in-state paper in those high-tax jurisdictions — states like California, New York, Connecticut, Massachusetts, Minnesota, to name a few. The SALT and mortgage deduction provision also has implications for issuers. Considering the fact that state and local issuers, particularly local issuers, derive most of their revenue from property tax revenues — if in fact lower deductibility for SALT and mortgage tax winds up in lower property values — assessed valuations will fall and tax revenues will fall, something that could play a role potentially, in the medium or long term to the credit-worthiness of some of these entities.

Outlook for AMT spreads

From an individual perspective, exemptions and phase out levels were changed. Ultimately, what is means is fewer investors will be subject to AMT, and so we saw AMT spreads tighten. We do think that the market will maintain those spreads, and then it will take time as individual investors go to their accountants or do their own taxes and figure out what the, what their, current status is. We do believe that AMT spreads will continue to narrow in the future.

The views expressed represent the Managers’ assessment of the market environment as of January 2018 and should not be considered a recommendation to buy, hold, or sell any security, and should not be relied on as research or investment advice.

Past performance does not guarantee future results.

Investing involves risk, including the possible loss of principal.

SALT refers to the state and local tax deduction.

AMT refers to the Alternative Minimum Tax.

Fixed income securities and bond funds can lose value, and investors can lose principal, as interest rates rise. They also may be affected by economic conditions.

Bond funds may also be subject to prepayment risk, the risk that the principal of a fixed income security that is held by the Fund may be prepaid prior to maturity, at the time when interest rates are lower than what the bond was paying. A portfolio may then have to reinvest that money at a lower interest rate.

High yielding, non-investment-grade bonds (junk bonds) involve higher risk than investment grade bonds.

Funds that invest primarily in one state may be more susceptible to the economic, regulatory, and other factors of that state than funds that invest more broadly.

Substantially all dividend income derived from tax-free funds is exempt from federal income tax. Some income may be subject to state or local taxes and/or the federal alternative minimum tax (AMT) that applies to certain investors. Capital gains, if any, are taxable.

Other than Macquarie Bank Limited (MBL), none of the entities noted are authorised deposit-taking institutions for the purposes of the Banking Act 1959 (Commonwealth of Australia). The obligations of these entities do not represent deposits or other liabilities of MBL. MBL does not guarantee or otherwise provide assurance in respect of the obligations of that entity, unless noted otherwise.

The Funds are distributed by Delaware Distributors, L.P., an affiliate of Macquarie Investment Management Business Trust (MIMBT), Macquarie Management Holdings, Inc., and Macquarie Group Limited. Macquarie Investment Management (MIM), a member of Macquarie Group, refers to the companies comprising the asset management division of Macquarie Group Limited and its subsidiaries and affiliates worldwide.

© 2018 Macquarie Management Holdings, Inc.

(428161) 02/18

In this video, Munis and tax reform: Corporate tax rate challenges, Gizzi explains why a lower corporate tax rate could present challenges for the municipal market going forward.

Gregory A. Gizzi

Senior Portfolio Manager

So the corporate tax rate is more challenging for the municipal market on a going-forward basis. If we go back historically — and let’s use the Federal Reserve’s last Z.1 release, which gives municipal holdings by investor class — banks, life insurance companies, and property and casualty corporations held collectively about 30% of the market. The initial fear in the market was that if corporate tax reform did in fact go through that there would be outright selling. We’re not in that camp simply because those entities had been very opportunistic at higher interest rate levels and wider spreads and therefore there’s no real incentive to sell those bonds, quite frankly. What could happen, realistically, is that on a going-forward basis, demand could be somewhat challenged. And so what our opinion is, is that those entities become more opportunistic in focus when they look at the municipal asset class. We will have to trade cheaper, relative to US Treasurys in order to garner the attention of those entities on a going-forward banks’ basis.

Implications for AMT

From a corporate standpoint, with the AMT being repealed, historically speaking, corporations aren’t big purchasers of AMT paper, but it does make AMT paper more attractive for those that do buy it.

For financial professional use only.

The views expressed represent the Managers’ assessment of the market environment as of January 2018 and should not be considered a recommendation to buy, hold, or sell any security, and should not be relied on as research or investment advice.

Past performance does not guarantee future results.

Investing involves risk, including the possible loss of principal.

AMT refers to the Alternative Minimum Tax.

Fixed income securities and bond funds can lose value, and investors can lose principal, as interest rates rise. They also may be affected by economic conditions.

Bond funds may also be subject to prepayment risk, the risk that the principal of a fixed income security that is held by the Fund may be prepaid prior to maturity, potentially forcing the Fund to reinvest that money at a lower interest rate.

High yielding, non-investment-grade bonds (junk bonds) involve higher risk than investment grade bonds.

Funds that invest primarily in one state may be more susceptible to the economic, regulatory, and other factors of that state than funds that invest more broadly.

Substantially all dividend income derived from tax-free funds is exempt from federal income tax. Some income may be subject to state or local taxes and/or the federal alternative minimum tax (AMT) that applies to certain investors. Capital gains, if any, are taxable.

Other than Macquarie Bank Limited (MBL), none of the entities noted are authorised deposit-taking institutions for the purposes of the Banking Act 1959 (Commonwealth of Australia). The obligations of these entities do not represent deposits or other liabilities of MBL. MBL does not guarantee or otherwise provide assurance in respect of the obligations of that entity, unless noted otherwise.

The Funds are distributed by Delaware Distributors, L.P., an affiliate of Macquarie Investment Management Business Trust (MIMBT), Macquarie Management Holdings, Inc., and Macquarie Group Limited. Macquarie Investment Management (MIM), a member of Macquarie Group, refers to the companies comprising the asset management division of Macquarie Group Limited and its subsidiaries and affiliates worldwide.

© 2018 Macquarie Management Holdings, Inc.

(428171) 02/18

In this video, Munis and tax reform: A closer look at supply, Gizzi explains how provisions in the tax legislation affected year-end market performance. He also provides an in-depth look at how these changes could affect municipal market supply in 2018.

Gregory A. Gizzi

Senior Portfolio Manager

The tax bill for the municipal market was a mixed bag. There are certain elements that will help from a technical standpoint, namely the supply demand technical, and then there are other aspects that, on a medium- to longer-term basis, must be monitored for potential credit degradation.

Tax bill effects on year end performance

The tax bill had a significant impact on the market at year end. Once the House bill was released and both advanced refunding bonds and private activity bonds were eliminated, issuers did not waste time in any advanced refunding issue or private activity bond that was able to come to market [and] did in fact come to market. The impact that had was a substantial pull forward of supply from 2018 into December of 2017, and ultimately we ended up with a record month of December, about $63 billion in supply. That surpassed the previous record which was in December of 1985, of $55 billion, which happen to be before 1986 tax reform.

Implications of advanced refunding elimination

So ultimately advanced refunding bonds were eliminated and private activity bonds were spared in the final tax bill. What that means for the market on a forward-going basis is that no longer can issuers use an advanced refunding tool to lower their debt expense. They have to do what’s called a current refunding, where a deal is refunded within 90 days. Historically speaking, that represents about 10 to 15% of the supply in our market, so on a going-forward basis you can expect supply to be lowered by that amount.

PAB effects on the market

Private activity bonds represented about another 15% of the market, and it’s important to note that private activity bonds are mostly in revenue bond sectors that trade at premium yields to higher grade securities. It’s quite frankly where a lot of alpha is generated. So if private activity bonds were in fact eliminated from the market, you would have had a further shrinkage in the market on a going-forward basis and some of the yield opportunities that are in the marketplace would have been eliminated for investors as well.

Supply outlook for 2018

So, with the issuance that was pulled forward from 2018 into 2017 as a result of private activity bond issuers and advanced refunding issuers taking advantage prior to the enactment of the law, it becomes a difficult proposition to predict supply. Generally speaking, I think the consensus view is about $40 billion of paper was pulled forward, and we were already looking at a lower supply figure heading into 2018 prior to tax reform on the basis that over the last few years, many issues, many advanced refunding issues, were already pulled forward. So if we look at a range, if last year we wound up down about 10% year over year, coming in about $415 billion, we suspect that this year will be lower, somewhere in the $300 to 350 billion range, depending on rates and depending on the amount of current refunding activity that occurs in the market.

For financial professional use only.

The views expressed represent the Managers’ assessment of the market environment as of January 2018 and should not be considered a recommendation to buy, hold, or sell any security, and should not be relied on as research or investment advice.

Past performance does not guarantee future results.

Investing involves risk, including the possible loss of principal.

PAB refers to private activity bonds.

Fixed income securities and bond funds can lose value, and investors can lose principal, as interest rates rise. They also may be affected by economic conditions.

Bond funds may also be subject to prepayment risk, the risk that the principal of a fixed income security that is held by the Fund may be prepaid prior to maturity, at the time when interest rates are lower than what the bond was paying. A portfolio may then have to reinvest that money at a lower interest rate.

High yielding, non-investment-grade bonds (junk bonds) involve higher risk than investment grade bonds.

Funds that invest primarily in one state may be more susceptible to the economic, regulatory, and other factors of that state than funds that invest more broadly.

Substantially all dividend income derived from tax-free funds is exempt from federal income tax. Some income may be subject to state or local taxes and/or the federal alternative minimum tax (AMT) that applies to certain investors. Capital gains, if any, are taxable.

Other than Macquarie Bank Limited (MBL), none of the entities noted are authorised deposit-taking institutions for the purposes of the Banking Act 1959 (Commonwealth of Australia). The obligations of these entities do not represent deposits or other liabilities of MBL. MBL does not guarantee or otherwise provide assurance in respect of the obligations of that entity, unless noted otherwise.

The Funds are distributed by Delaware Distributors, L.P., an affiliate of Macquarie Investment Management Business Trust (MIMBT), Macquarie Management Holdings, Inc., and Macquarie Group Limited. Macquarie Investment Management (MIM), a member of Macquarie Group, refers to the companies comprising the asset management division of Macquarie Group Limited and its subsidiaries and affiliates worldwide.

© 2018 Macquarie Management Holdings, Inc.

(428178) 02/18


Fixed income securities and bond funds can lose value, and investors can lose principal, as interest rates rise. They also may be affected by economic conditions that hinder an issuer’s ability to make interest and principal payments on its debt.

The views expressed represent the Manager's assessment of the market environment as of January 2018, and should not be considered a recommendation to buy, hold, or sell any security, and should not be relied on as research or investment advice. Views are subject to change without notice and may not reflect the Manager's views.


Carefully consider the Funds' investment objectives, risk factors, charges, and expenses before investing. This and other information can be found in the Funds' prospectuses and their summary prospectuses, which may be obtained by visiting delawarefunds.com/literature or calling 800 362-7500. Investors should read the prospectuses and the summary prospectuses carefully before investing.

IMPORTANT RISK CONSIDERATIONS

Investing involves risk, including the possible loss of principal.

Past performance does not guarantee future results.

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