Will US Tax Reform Alter the Muni Landscape?

With a new US tax law now upon us, many investors are questioning what the potential impacts may be on their portfolios—and on their potential investment selections going forward. Rafael Costas and Sheila Amoroso, co-directors of Franklin Templeton Fixed Income Group’s Municipal Bond Department, address the major areas of potential impact the new legislation could have on muni bonds, and offer their thoughts around each of these areas.

The recent passage of the US tax reform bill has caused some uncertainty within the municipal bond market. But, it’s not necessarily bad news.

Supply Impact

Overall, we feel supply will decline somewhat from the elevated levels we saw in 2017, when many issuers issued debt they were intending to issue in 2018. Concerns about changes in the tax code that could affect certain kinds of bond issues led to the acceleration of those plans into 2017. The two primary areas of concern were advanced refundings and what are known as private activity bonds. Early versions of the tax bill were targeting the removal of the tax-exemption for each type.

Advanced refunding debt allows issuers to take advantage of refinancing opportunities before a bond’s first call date. We would note that advanced refundings lost the tax exemption only on a prospective (going forward) basis; outstanding advanced refundings are “grandfathered.”

Private activity bonds usually finance projects that have some component of private activity, but that are deemed to also meet “public needs.” While projects like stadia are often quoted as an example of “abuse,” the fact is that the majority of these bonds are issued by hospitals, private colleges, airports, housing authorities and electric utilities that use the proceeds for pollution control equipment, for example.

In the final tax legislation, private activity bonds were left untouched while advanced refunding bonds lost their tax-exemption. We believe that, given the current very low interest-rate environment, advanced refunding debt was not going to be a very significant part of the municipal market in the foreseeable future.