Munis Stronger as Analysts Weigh Future Impact of Tax Reform
Municipal bonds strengthened Thursday as market analysts expressed concern a proposal in a tax reform bill introduced in Washington would curtail issuance by eliminating advanced refundings and private activity bonds.
In the biggest deal of the week, Bank of America Merrill Lynch priced and repriced the Virginia Small Business Financing Authority’s $737 million of senior lien private activity refunding bonds for the Transform 66 P-3 Project. The bonds were repriced to yield 3.71% with a 5% coupon in 2047, 3.79% with a 5% coupon in 2049, 3.90% with a 5% coupon in 2052 and 4.00% with a 5% coupon in 2056. The deal is rated Baa3 by Moody’s Investors Service and BBB by Fitch Ratings.
At repricing yields were bumped eight basis points in the 2047 and 2049 maturities, seven basis points in 2052 and five points in 2056.
“This deal was very attractive and with the way it was bumped, the demand was very strong,” said a New York trader. “It also helped that there are lots of people out their looking for yield and this was a yieldier deal.”
Since 2007, the authority has issued about $2.7 billion of debt with the most issuance before this year occurring in 2012 when it sold $905 million. It did not come to market in 2013, 2015 or 2016.
Muni pros said a proposed House Republican tax bill would shrink the municipal market by halting advance refundings and private activity bonds after the end of this year.
“I put the likelihood of bill passage at somewhere below 50%, based primarily on the contentious D.C. environment and competing lobbying efforts by various interest groups,” said Alan Schankel, managing director and municipal strategist at Janney. “That being said, I suspect if bill is eventually passed, the provision to eliminate advance refundings, by making interest taxable, will make the final cut.”
He said passage of this restriction on advance refundings will certainly have a negative impact on new municipal issue volume in future years, albeit with a uptick in volume through year-end 2017 as issuers and bankers advance refund before the door closes, even if savings are small.
Matt Fabian, partner at Municipal Market Analytics, said that MMA has been pessimistic that Republicans can pass a tax reform bill before year-end and the latest news coming out today increases the firm’s conviction in that.
“Advance refundings are less important now, then they were 10 years ago, but state and local issuers still use them to lock in low interest rates,” he said. “The loss of advance refunding capability could lead issuers to dial back investors’ call protection to allow earlier current refundings. This will push yields modestly higher in the primary market and would hurt crossover investor demand perhaps the worst.” Tom Kozlik, managing director and municipal strategist at PNC Capital Markets said that while it is difficult to say how it plays out, comprehensive tax reform is difficult to pass even under optimal circumstances. “It took lawmakers three-ish years to hammer out 1986 tax reform. Therefore, it seems like time could be working against the proposal.”
Top-shelf municipal bonds were stronger to close out Thursday.
The yield on the 10-year benchmark muni general obligation was two basis points lower to 2.00% from 2.02% on Wednesday, while the 30-year GO yield was also two basis points lower to 2.80% from 2.82%, according to a final read of Municipal Market Data`s triple-A scale.
U.S. Treasuries were stronger at the market close on Thursday. The yield on the two-year Treasury dipped to 1.61% from 1.62%, the 10-year Treasury yield fell to 2.35% from 2.37% and yield on the 30-year Treasury bond slipped to 2.83% from 2.86%.
On Thursday, the 10-year muni-to-Treasury ratio was calculated at 85.2% compared with 83.2% on Wednesday, while the 30-year muni-to-Treasury ratio stood at 98.9% versus 98.6%, according to MMD. ◽