Se­nate Tax Hur­dle May Hurt Mu­nis

The Bond Buyer - - Front Page - BY LYNN HUME

WASH­ING­TON – If the Se­nate Repub­li­can tax bill looks sim­i­lar to the House Repub­li­can bill, things could go from bad to worse for the mu­nic­i­pal bond mar­ket, ac­cord­ing to tax ex­perts and econ­o­mists.

Se­nate Fi­nance Com­mit­tee chair Or­rin Hatch, R-Utah, said on Fri­day that Se­nate Repub­li­cans may re­lease their tax bill by Oct. 10.

If Se­nate Repub­li­cans want to in­clude in their bill most of the con­cepts in the House GOP bill it may have to find even more rev­enue rais­ers to meet the so-called Byrd rule and al­low it to pass a tax bill un­der the rec­on­cil­i­a­tion process with a sim­ple ma­jor­ity vote. And muni bonds are al­ways on the ta­ble as po­ten­tial rev­enue rais­ers.

Un­der the Byrd rule, any Se­nate bill go­ing through the rec­on­cil­i­a­tion process can’t have rev­enue losses and an in­crease in the deficit be­yond a 10-year pe­riod.

The House Repub­li­can bill would in­crease the deficit by $166.8 bil­lion in 2027, the tenth year, ac­cord­ing to the Joint Com­mit­tee on Tax­a­tion, and there’s noth­ing to in­di­cate those losses would lessen the fol­low­ing year.

“There’s no ques­tion that the bill would not meet the Byrd rule,” said John Buck­ley, for­mer House Ways and Means Com­mit­tee Demo­cratic tax coun­sel.

Al­ter­na­tively, the Se­nate could also cut or make tem­po­rary some of the spend­ing pro­vi­sions to get a deficit-neu­tral tax bill by 2027 and that would lessen the need for rev­enue rais­ers and be good for the muni mar­ket.

While most muni mar­ket par­tic­i­pants are fo­cused on the di­rect im­pacts to mu­nis from the House Repub­li­can bill – the pro­posed ter­mi­na­tion of pri­vate ac­tiv­ity bonds and ad­vance re­fund­ings -- tax ex­perts said don’t dis­count the harm that would come to the muni mar­ket from a 20% cor­po­rate tax rate.

Buck­ley said that rate would be “de­struc­tive” and take banks,

life in­sur­ance com­pa­nies and prop­erty and ca­su­alty in­sur­ance com­pa­nies, out of the mu­nic­i­pal mar­ket. Cur­rently about 25% of tax-ex­empt bonds are held by banks and th­ese in­sur­ance com­pa­nies ac­cord­ing to bond ex­perts.

Ge­orge Fried­lan­der, manag­ing part­ner at Court Street Group Re­search, said, “At a 20% tax rate, muni yields would have to rise sharply be­fore mu­nic­i­pals would be com­pet­i­tive with tax­able in­vest­ments for a cor­po­rate in­vestor, such as a com­mer­cial bank or a prop­erty and ca­su­alty in­surer.”

Fried­lan­der said the 20% rate, by it­self, could push mu­nic­i­pal bond yields up by 50 to 75 ba­sis points, even be­fore the pro­posed PAB and ad­vance re­fund­ing pro­vi­sions are con­sid­ered.

That would make bor­row­ing more ex­pen­sive for is­suers. Fried­lan­der said that House Repub­li­cans, for all their talk about the U.S. cor­po­ra­tions be­ing com­pet­i­tive with their global coun­ter­parts, could have pro­posed a 29.4% cor­po­rate rate and still have been at the av­er­age global cor­po­rate rate (weighted by gross do­mes­tic prod­uct).

“There are sev­eral pro­vi­sions in this tax bill that are likely to af­fect the pric­ing of mu­nic­i­pal bonds,” said Richard Chirls, a part­ner at Or­rick Her­ring­ton & Sut­cliffe.

For ex­am­ple, he said, own­ers of passthrough en­ti­ties such as part­ner­ships and Subchap­ter S Cor­po­ra­tions will also be less likely to buy mu­nis, thereby damp­en­ing de­mand for mu­nis and rais­ing muni prices, be­cause they will only be sub­ject to a 25% tax rate rather than a rate that is now as high as 39.6%.

As for de­fend­ers of muni bonds, some banks and cor­po­ra­tions in­volved in pri­vate ac­tiv­ity bond deals may pre­fer to have their tax rates re­duced to 20% rather than quib­ble about muni bond pro­vi­sions.

“Wall Street will be just as happy to un­der­write tax­able bonds as tax-ex­empt bonds,” said Buck­ley.

Mean­while, the mu­nic­i­pal bond mar­ket may see a huge rush of PAB and ad­vance re­fund­ing deals this month and next as is­suers to cover their bases in case Congress passes a tax bill be­fore the end of the year that ter­mi­nates those fi­nanc­ings.

“I an­tic­i­pate that there will be a lot of trans­ac­tions that will be moved to De­cem­ber to ad­dress the risk that the tax law will be changed,” said Chirls.

“We’re warn­ing peo­ple, we’re get­ting in­quiries,” said Milt Wakschlag, a part­ner at Kat­ten Muchin Rosen­man in Chicago. “Deals can be done this year by they have to be timely. There is a long­stand­ing tax pro­hi­bi­tion on is­su­ing bonds ear­lier than nec­es­sary be­cause that would be con­sid­ered an over-is­suance.”

He and oth­ers said that is­suers that have had PAB or ad­vance re­fund­ing trans­ac­tions in the pipe­line will def­i­nitely con­sider do­ing them be­fore the end of the year.

It might even be worse to go into next year with pend­ing tax bills that pro­pose to ter­mi­nate PABs and ad­vance re­fund­ings at the end of 2017, than to have an ac­tual tax bill passed that in­cludes those pro­vi­sions, he said, adding this would cause enor­mous un­cer­tainly and chaos in 2018.

“But this not go­ing down with­out a fight,” he said, re­fer­ring to ef­forts to try to con­vince Congress to back away from the at­tacks on mu­nis. ◽

Ge­orge Fried­lan­der, manag­ing part­ner at Court Street Re­search Group. said the House GOP’s pro­posed 20% cor­po­rate rate could re­ally hurt mu­nis.

There are sev­eral pro­vi­sions in this tax bill that are likely to af­fect the pric­ing of mu­nic­i­pal bonds,” said Richard Chirls, a part­ner at Or­rick Her­ring­ton & Sut­cliffe.

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