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.
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